If you have children or plan to have children in the future, you are aware that costs of education are expensive and continue to increase. Many people save for higher educational expenses by utilizing a custodial account or even a trust. Another great option for saving for your child or grandchild’s educational costs is a 529 plan.
What is a 529 Plan?
A 529 plan is a tax-advantaged savings plan designed to help pay for educational costs from kindergarten to post-secondary education. A 529 savings plan grows tax-deferred and withdrawals are tax free if they are used for qualified education expenses. Qualified expenses include tuition, fees, room and board, and related costs. These types of accounts are typically established by parents or grandparents who will then name a child or grandchild as the account’s beneficiary. The account owner controls the funds within a 529 plan and decides when withdrawals are made.
You may be able to get a state income tax deduction for establishing a 529 plan.
What if the 529 beneficiary does not use all the funds in a 529?
You have set up a 529 plan for your child and he or she either does not attend college or receives a substantial amount in scholarships. There is still renaming funds in the 529 plan. What can you do now?
One of the options is to change the beneficiary of the account to another family member such as another child, grandchild, brother, etc. This results in no taxes or penalties. Another option is to keep the current beneficiary and wait to see if they change their mind about going to college or later pursuing graduate school. Finally, you can always withdrawal the funds and pay the taxes as well as a 10% penalty.
Tax and Estate Plan Benefits of a 529 Plan
While the money you contribute to a 529 plan is not tax deductible for federal income tax purposes, it will grow tax free and distributions are tax-free if used for qualified expenses. Further, if you live in Illinois, you can claim a deduction of up to $10,000 per year ($20,000 if married and jointly filing) on your state income tax and you will pay no state income tax on earnings and withdrawals that are used for qualified expenses.
Utilizing a 529 plan can also have estate planning benefits, especially for high net worth clients who are looking to minimize potential estate taxes. The value of the 529 account will not usually be included in the net value of the estate. Instead, the value of the account will be included in the estate of the designated beneficiary of the 529 account. This means that a 529 plan is not usually included in valuing the total estate value of the owner.