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It is no secret that higher education costs have increased dramatically in the past few decades. In 1987 the average annual tuition and fees for an in-state public institution was about $3,190. By 2017 that amount had more than tripled, to an average of $9,970.  The cost of a private school education more than doubled during the same time, from $15,160 per year to well over $35,000. As a result, saving for a child’s future education costs became an increasingly important financial goal for many parents.

          One vehicle designed to encourage savings for future higher education costs is known as a 529 Plan. Named after Section 529 of the Internal Revenue Code, 529 Plans gained their current tax advantages in 2001, and were expanded to include K-12 public, private and religious school tuition in 2017. American families have well over $300 billion saved in 529 Plans.

          There are two types of 529 Plans; prepaid plans and savings plans. Prepaid plans allow the purchase of future tuition credits at today’s rates. They are administered by the state or the academic institutions themselves. Ten states currently offer prepaid plans, including Nevada. The more tuition increases, the better the return on a prepaid plan.

          Savings plans are more like a standard investment account; growth is dependent on the market performance of the underlying investments, which are typically mutual funds. Savings plans are administered by the states, but the actual administrative services are often delegated to a financial services company.

          Contributions to a 529 Plan are considered gifts under federal tax regulations, so giving more than $15,000 per year ($75,000 over five years) for single filers, or $30,000 per year ($150,000 over five years) if filing jointly, will count against the gift tax exemption. Consult your tax advisor for more detailed information.

          Money from a 529 Plan can be used for qualified educational expenses at any accredited college, university or vocational school in the country, and some foreign universities as well. Qualified expenses include tuition, fees, books, computers, supplies, equipment required for study, and room and board, or off-campus housing costs up to the room and board allowance. Student loans and the interest on them do not qualify.

Advantages

          Nevada does not have a state income tax, so the state income tax benefits that some states provide are not an advantage here. However, we can still take advantage of the primary 529 Plan benefits, which are the tax-deferred growth of principal and the exemption from tax on qualified distributions for the beneficiary’s college expenses.

          As the donor, you maintain control of the account, with the beneficiary having little or no rights to the funds. Although you can reclaim the money for your own use, if you make a “non-qualified” withdrawal, the earnings portion would be subject to income taxes and a 10% penalty.

          529 Plans are simple and convenient to establish. The assets are professionally managed, and the donor does not even receive a 1099 form until withdrawals begin. Investments can be changed and the account rolled over to a different state’s plan. Fees are generally low, there are few eligibility restrictions, and most states allow significant ($300,000 or more) amounts to be saved.

          It is also possible to use 529 Plans as an estate planning tool. The assets are not counted as part of donor’s estate, and as noted above, the donor still retains control over the account if the funds are needed.

          Unused amounts can be transferred to qualified members of the beneficiary’s family without incurring any tax penalty. This is known as a “Rollover” and is explained in detail in IRS publication 970, in the Qualified Tuition Program section. This section also details the family members who qualify for a Rollover.

          Finally, since the 529 Plan is treated as an asset of the account owner, which is usually the parent, it has little impact on the student’s financial aid eligibility.

Disadvantages

          The investment options for 529 Plans are limited and IRS rules permit only two exchanges or reallocation of assets per year. Since the plans are offered on a state by state basis, the fees charged by your state’s plan may be higher than other alternatives. 529 Plans are not required to disclose their expense ratios in marketing materials, making it more difficult to comparison shop.

          As noted above, withdrawing money for use other than qualified college expenses will result in the earnings portion being subject to income tax and an additional 10% federal tax penalty. If any state tax credits or deductions were taken, these may be subject to recapture.

          If someone besides the parent owns the 529 Plan, paying qualified expenses from the account may affect a student’s eligibility for need-based financial aid. Paying qualified college expenses directly from a 529 Plan may also reduce eligibility for the American Opportunity Tax Credit.

          From a financial aid perspective, most advisors agree that the parents, rather than, say, the grandparents, should own the 529 Plan. Most colleges use the government’s FAFSA (Free Application for Federal Student Aid) form to determine what the family can afford to pay for college. Income, assets, and other obligations are all considered. If the parent owns or is the custodian of the account, it is considered at 5.64% of its value, which is far less than a student owned savings or brokerage account. Should someone else own the account, it will not show up on the FAFSA at all, but distributions will show up as untaxed income on the following year’s form, which could drastically affect financial aid eligibility. There are some alternatives, so be sure to consult your tax advisor.

          Most plans allow the owner to designate a successor in case of death, and/or allow a joint account owner. Some plans do not allow an ownership change. If your plan does, and you need to do that, be aware that this might affect the student’s eligibility for financial aid. Also, remember that the new owner has full control over the beneficiary’s money.

          If you and/or your spouse have set up a 529 Plan for your children and are now getting a divorce, you will need to determine what happens to this asset. Hopefully, since it was established for the benefit of your children, an agreement can be reached. Be sure to consult with an experienced family law attorney.