What is a 529 Plan and How Can One Benefit Me?

A 529 plan is a tax-advantaged way for families to save money for higher education expenses. It allows you to make current year after-tax contributions to the plan while the funds accumulate tax-free. To avoid taxation on the growth, the funds must be utilized for qualifying education expenses. Qualifying education expenses include tuition, fees and books, as well as room and board. Anyone can contribute to a 529 plan – parents, grandparents, and other family members.

How has tax reform changed 529 plans?

With the 2017 Tax Cuts and Jobs Act (TCJA) came a modification of the rules for 529 plan funds. Formerly, the funds were allowed to be used only for higher education expenses, such as education at a college, university or vocational school. Beginning in 2018, up to $10,000 in a 529 plan can also be used annually for expenses incurred for elementary and secondary education. This includes expenses for the 529 plan’s designated beneficiary at a public, private, or religious elementary or secondary school. The $10,000 limitation applies on a per-student basis for distributions from all 529 accounts. The TJCA also modifies 529 plans to:

1. Allow distributions to be used for certain expenses required for attendance in a registered apprenticeship program, and

2. Specify that an unborn child may qualify as a designated beneficiary.

This opens the door for these expenses to be utilized for more of the beneficiary’s education.

State of Michigan deduction

Some states allow for a deduction when contributing to the plan. The State of Michigan allows a deduction of up to $10,000 per year if contributing to Michigan’s sponsored plan (MESP). So, you may be thinking that you will contribute to the plan to get the state deduction and pay the tuition that same year. There is a catch: the Michigan deduction is only allowed on the net contributed to the plan that year. For example, if you contribute $5,000 into the plan on January 1, 2018, then on July 1 of the same year, you make a $4,000 qualified distribution to pay your child’s school tuition, the net into the plan in 2018 is only $1,000. Therefore, the deduction on the Michigan tax return will be $1,000 for that year.

Rollover to another beneficiary’s plan

What if you are concerned that you have created a 529 plan and are not sure if your child will go to college or use these funds in primary or secondary school? Well, there is good news. You can roll over the unused funds to another beneficiary’s 529 plan. Qualifying members of the beneficiary’s family include: their spouse, child, stepchild, foster child, adopted child, (or a descendent of any of them), their siblings and stepsiblings, father or mother or stepparents, nieces or nephews, aunts and uncles, certain in-laws, spouses of any of the previously listed, and first cousins.

Remember that the true benefit of a 529 plan is the accumulation of earnings in a tax-free environment. When considering a distribution, consider the funds available and the plan beneficiary’s future education needs.

I recommend that you speak with a tax professional regarding your personal situation.