3. Contributing to a 529 can help you manage your taxes, from estate taxes to income taxes. If one of your goals is to avoid leaving your heirs with hefty tax penalties after your death, making a large contribution to a 529 plan can help. Just be sure not to exceed the annual gift tax exclusion amount ($15,000 for individuals or $30,000 for married couples), or you’ll have to report the gift to the IRS, although in most cases no tax will be due.
There is, however, a way to make larger contributions to 529s, using five-year gift tax averaging. You can deposit up to $75,000 (or $150,000 for married couples), and the money will be treated as if it were given incrementally over five years. That means you can front-load the account as long as you don’t make additional contributions that exceed the annual gift tax exclusion amount during those five years. A tax advisor can help you sort through the tax implications of contributing to a 529 plan.
Depending on your state of residence and the specifics of the 529 plan you contribute to, your gift may also earn you an income tax deduction. In some states, the deduction is only available to the account owner, so that may help you determine whether you want to contribute to a student’s existing 529 plan or start an additional one for the student on your own.
4. As 2020 has taught us, even the best-laid plans can change. What if the person you opened a 529 account for decides on a different path that doesn’t include college? Or the student gets a full-ride scholarship and doesn’t need the money anymore? When plans change, 529 accounts can be used for another type of school, such as graduate school, or the beneficiary can be changed to anyone in the person’s immediate family. If your beneficiary receives scholarship money, you can withdraw that total amount from the 529 account without having to pay a penalty, though you may need to pay taxes on the earnings. Be sure to consult with a tax professional in this situation.
During the recent coronavirus pandemic, many schools provided students with refunds for a portion of tuition or room and board due to facilities closing and classes being held virtually. It’s important to remember that in such circumstances, that refund must be redeposited into the 529 plan or the account owner may be subject to penalty. If students delay starting or returning to college until the pandemic subsides, their 529 plan will not be impacted by the gap in their education.
Four Ways to Think Outside the 529
If you decide a 529 plan isn’t right for you, there are plenty of other ways to help your relative or friend’s child prepare for college.
- Give cash. Outright cash gifts are always appreciated. Just be aware of tax implications for larger gifts, and keep in mind that they may count against the student’s financial aid more than money in a 529 plan would.
- Pay off the student’s debt. Consider waiting until the student finishes college and then pay off—or help pay off—student loans. This strategy also gives the student incentive to finish school, if that’s something you’re concerned about.
- Pay the university directly. Paying the student’s tuition directly to the school is not considered a cash gift, so there are no tax implications to worry about. But it could negatively affect how much financial aid the student can obtain the next school year.
- Buy U.S. savings bonds or set up an educational trust fund. Certain savings bonds have tax benefits when used for qualifying education expenses, and you can set up trust funds for use while you’re still living or after your death.
Of course, money isn’t everything. A young person can also benefit from your lifetime of experience. Helping someone learn about budgeting and financial responsibility could be your most valuable gift as that person heads out into the world for the first time.
If you’re considering helping someone with educational expenses, talk to your financial advisor about your goals. Your advisor can help you determine the best path forward, keeping an eye on how the contributions may impact other goals you may have.