529 account

While most Americans are acutely aware of the rising costs of education, some are still unfamiliar with the 529 account: a tax-advantaged savings tool designed to help them save for these costs. Here, we explore the most frequently asked questions existing and prospective 529 investors have.

What is a 529 account? Why is it called a 529?

A 529 account is a tax-advantaged investment account designed to help Americans to save for future education costs. The account’s title comes from Section 529 of the Internal Revenue Code, which was established as a part of the Small Business Protection Act of 1996.

Who is eligible to open a 529 account?

Just about anyone can open an account to save for anyone else. The saver can be a parent, grandparent, second cousin twice removed, or even a friend as long as he or she is a U.S. citizen or resident alien age 18+.

Who is eligible to be a beneficiary? Can you open up a 529 account for yourself?

The only eligibility requirement for a 529 beneficiary is that they are a U.S. citizen or resident alien with a social security or tax ID number. Typically, parents or grandparents utilize 529 accounts for their children or grandchildren. However, in cases of continuing higher education such as pursuing a Master’s Degree or Ph.D., students can take advantage of tax benefits by opening up a 529 account for themselves.

 Are there contribution limits for 529 accounts?

There are no federal contribution limits for 529 plans. However, after $15,000 per year, a federal gift tax is triggered. Contribution limits are usually set by the state and can even be as high as $500,000.

How and where can 529 savings be spent?

529s aren’t just for your typical 4-year schools; they are also good at community colleges, vocational and trade schools, and even for private K-12 education in given states. 529 account balances can only be used to cover approved expenses which can include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible school, certain room and board costs, certain computer related expenses, and even required expenses for special needs students.

What happens if funds are used for non-approved expenses?

If 529 account funds are used for non-approved expenses, you’ll have to pay taxes on that money, plus a 10% penalty. If you took advantage of a state tax break, you may have to pay that back as well.

What happens to a 529 account if it is only partially used or not at all?

Leftover 529 account funds can be transferred to a family member. However, if you want to withdraw money from the account for anything other than approved education expenses, you will have to pay taxes on that money as well as a 10% penalty. If you took advantage of a state tax, you may have to pay that back as well. If the beneficiary gets a full scholarship to college, the penalty for withdrawing the account balance is waived.

Why should I save in a 529 account versus borrow for my education expenses through a federal student loan program?

Saving for future education with a 529 account allows you to leverage the power of compound interest as well as take advantage of tax benefits. Borrowing money through a federal student loan program can be much more expensive in the long run because, in addition to missing out on tax benefits, additional fees and interest expenses can quickly add up.

Being proactive and using a 529 account to save for future education costs can potentially save you thousands of dollars down the line. For help planning for your child’s education or setting savings goals, check out our College Savings Planner. To learn more about 529 accounts and how to find the plan that’s right for you, visit www.howtosaveforcollege.com.

Many Americans need help when faced with a major expense or financial hardship, whether it’s paying for college, healthcare, food, or living expenses, or resolving debt. They may seek financial aid through a federal program or process. Depending on the program and the financial help needed, having money in a retirement savings account may affect how much financial assistance an individual receives.

Student Financial Aid

For many individuals, financial help is necessary when paying for higher education. When filing for federal student aid with the U.S. Department of Education Office of Federal Student Aid, the largest provider of student financial aid in the nation, an applicant is required to report many types of assets (the parents’ and the student’s). Those applying may wonder whether retirement savings accounts are included in these reportable assets. The answer depends on the formula used to determine how much financial aid the student is eligible to receive.

Balances in employer-sponsored retirement plans and IRAs generally are not included in the calculation. Whereas, nonretirement account balances, such as checking, savings, CDs, brokerage accounts, stocks, bonds, mutual funds, etc., are included. In essence, the balance in a retirement plan or IRA—whether owned by the parent or the student—is not counted. But any contributions to a retirement plan or IRA in the previous year—the tax year for which asset information is gathered—are counted. According to the Federal Student Aid worksheets, “Completing the FAFSA 2017-18” and “The EFC Formula, 2017-2018,” prior year contributions to pension, profit-sharing, 401(k), 403(b), SEP, and SIMPLE IRA plans and Traditional and Roth IRAs are viewed as untaxed income, and must be added back to the parent’s or student’s adjusted gross income portion of the calculation.

Any distributions from these plans or IRAs also are counted as income and are reportable assets for the following year’s financial aid application, according to savingforcollege.com. This is something to keep in mind when contemplating an IRA distribution or preparing to withdraw from a retirement plan during college years. Even distributions taken to pay for higher education expenses are counted as part of the student’s income for the following year’s financial aid eligibility.

Welfare and Medical Aid

How does an IRA or retirement plan affect one’s ability to qualify for other types of financial aid? It depends. For federal programs that are meant to help low-income Americans, like Medicaid or Children’s Health Insurance Program (CHIP), Temporary Assistance to Needy Families (TANF), Supplemental Nutrition Assistance Program (SNAP), and Supplemental Security Income (SSI), each state is allowed to establish—or eliminate—asset limits, the maximum dollar amount of assets that the applicant may own to qualify for the program. Although there is no federal asset limit, a common state-established dollar limit is $2,000.

Depending on the federal program and the state where the individual is applying for program benefits, certain resources, such as retirement accounts, may be included in the program’s asset and income limits. If included, saving for retirement could jeopardize the individual’s eligibility for the program. But there are variations and exceptions to this guideline that the individual will have to pay close attention to.

Most states generally do not count employer-sponsored retirement plans, such as a 401(k) plan, in the asset limit because a triggering event is needed to withdraw money; the account is not easily accessible to the needy individual. IRAs, on the other hand, which do not require a triggering event, are more likely to be counted in the asset limit. A typical rule is that an IRA counts if it is not in required minimum distribution (RMD) status . For example, a Traditional IRA owner who is not yet required to take RMDs may have to include his IRA balance as part of his assets when applying for a low-income government program, while someone who is taking RMDs may not. But any RMDs taken would be counted. Another common rule is to count the IRA if the IRA owner is age 59½ or older and the early distribution penalty tax no longer applies.

Bankruptcy

When financial circumstances force some individuals into bankruptcy, the possibility of surrendering their retirement savings is a valid concern. The good news is that retirement plan assets generally are exempt from bankruptcy. This means that the retirement plan assets of an individual filing for bankruptcy are protected from creditors. The exemption applies to the assets in an IRA, 401(k) plan, 403(b) plan, profit sharing plan, and other similar retirement savings vehicles.

Congress recognized the need to protect retirement assets and put in place federal exemptions that apply a minimum standard for “retirement funds” to be exempt. Each state may provide greater protections beyond the federal rules.

Assets in plans covered under the Employee Retirement Income Security Act of 1974 generally are excluded from one’s bankruptcy estate with no limit on the amount of assets protected by the exclusion. The exemption of IRA assets, however, is limited, with an inflation-adjusted cap currently set at $1,283,025. Each state can provide additional protection to IRA exemptions.

When faced with the daunting task of declaring bankruptcy, an individual can rest assured that his own retirement assets generally will be safe from creditor access.

Look to Program Rules and State Guidance

Saving for retirement often takes a backseat to one’s current financial circumstances and money set aside for retirement tends to be used for other more immediate needs. But those who qualify for certain federal programs and procedures may not have to sacrifice their hard-earned retirement savings, depending on program and state requirements.