How Flexible is a 529?

September 21, 2020

As college students started classes in a variety of familiar and nontraditional ways, we celebrated my daughter’s first birthday.  The current challenges facing higher education led me to reflect on how this current crisis might shape her educational experience, and to revisit our approach to her college savings planning.

It can be daunting to try and estimate the future costs of college.  Clients who are parents of young children sometimes ask: “Can tuition costs continue to increase at the rate they have in the past?”  “What if our future government makes some form of college free?”  Current circumstances seem to add to the uncertainty as universities face budget impacts with disrupted dorm occupancy and athletics.  Will the current crisis bring online education into the mainstream?  What will this all mean for tuition rates and the culture of higher education?

Over the past 50 years, U.S. college tuition rates have increased at an average rate of about 6% per year, according to the National Center for Education.  Meanwhile, student loan debt has ballooned, reaching $1.4 trillion by the end of 2019. 

Many parents and grandparents want to support their children’s, or grandchildren’s, college education. Since their creation in 1996, 529 plans have become the most popular college savings vehicle, with such plans holding over $371 billion at the end of 2019.  These state-sponsored plans are offered by all 50 states and the District of Columbia.

529 savers benefit from tax-deferred growth and tax-free withdrawals when funds are used for qualified higher education expenses (“QHEE”).  Non-qualified withdrawals, however, are subject to a 10% penalty and Federal tax on the earnings.  The penalty is waived in the cases of scholarship or disability. QHEE include tuition, room and board, and books and supplies. In recent years the list of permitted QHEE has been expanded to include computer purchases (in 2015); up to $10,000/year for private elementary through high school tuition (from late 2017); and student loan payments up to a lifetime cap of $10,000 per beneficiary (from 2019).

For high earning individuals a 529 can help lower taxable income during years when they face a high marginal tax rate, when compared to accumulating savings outside a 529 and being taxed annually on dividends. Some states offer state income tax credits or deductions for in-state 529 plan contributions. Georgia’s deduction recently increased to $8,000 per beneficiary per year.  Those with larger estates may welcome front-loading 529s up to $75,000 per donor, per beneficiary without gift tax implications, and with a consequent reduction of their taxable estates.  The significant appeal of 529s includes the absence of any distribution requirements by age of beneficiary, and the flexibility to change beneficiaries between relatives including those of the next generation. At present 529 rules allow funds to be managed to grow tax free for the benefit of future generations.

Time will tell what the future holds for higher education and 529 flexibility. I know I will be a keen observer as I watch my daughter grow, and her plans for higher education develop.

Cam Simonds