Lido Insights

6 June 2022

What to Know About a 529 Account

By Jon Teran, CFP®, Senior Wealth Manager,

In much simpler times, you only had a few choices when ordering coffee: regular or decaf, maybe with cream and sugar. In today’s coffee shops, one is faced with a daunting number of choices when ordering what was once a simple drink.

The same can be said for college savings strategies. Long gone are the days when parents and family members could earmark money in a handful of account types to help fund education for their students. These days, investors are faced with an overwhelming selection of account types and tactics.

As a result, investors might be inclined to avoid the topic altogether, and just pay for college expenses as they go for their student.  Yet, in the complexity of today’s choices for college savings, there are opportunities for investors, with some particularly attractive aspects for high-net-worth investors.

Let’s consider the 529 plan. 

A 529 plan is a tax advantaged savings account for qualified education expenses. 529 plans are sponsored by states or educational institutions.  Contributions to 529 plans are funded with after tax money, and do not receive a federal income tax deduction. While you do not have to use your own state’s plan, some states allow for a state tax deduction for residents who use their state’s plan.

There are no annual contribution limits, but plans have aggregate plan limits set by each state ranging from $235,000 to $550,000. Once a 529 plan reaches the specified level, it can continue to grow, but contributions are no longer allowed. Also, the IRS makes special provision for the annual exclusion amount ($16,000 in 2022) and allows a person to frontload 5 years of gifting into one year without cutting into their lifetime exemption.

Funds inside the 529 can typically be invested in a mix of conservative to growth-oriented investments.  Any growth is tax deferred, and withdrawals are tax free when used for qualified education expenses. Thanks to the SECURE Act, elementary, middle school and high school expenses can also qualify for favorable tax treatment of distributions.  There is no deadline as to when funds must be withdrawn, and the beneficiary of the plan can be changed.

One significant downside is that withdrawals from a 529 plan not used for qualified education expenses are taxed as ordinary income along with a 10% penalty to the owner. 

Even with this downside, there are still compelling reasons for high-net-worth investors to consider 529 plans for family members.  Potential tax-free distributions are more attractive the higher your tax bracket.  Funds contributed to a 529 plan are considered a completed gift outside the owner’s taxable estate with the account owner retaining control of the plan. And with careful estate and tax planning, high-net-worth investors can structure a multi-generational plan to fund college expenses tax free for future generations. 

In all of this, it is important to consult your legal, tax and financial advisor because of the many factors to consider when navigating the nuances of 529 plans.  Time invested developing a strategy will be well worth it, especially to the degree it helps you focus on what’s important, like talking with your graduate one day about all they learned in college, perhaps even over a cup of coffee, however they take it.

Written By

Jon Teran, CFP<sup>®</sup>-Senior Wealth Manager
Jon Teran, CFP®
Senior Wealth Manager

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