All about 529 plans
This is part two of a series on the different vehicles used to save and invest so your money is aligned with what you value. You can read Part One here.
Disclaimer:
This information is presented for educational purposes only and is not advice or a recommendation to act. This article includes opinions of the writer which should not be construed as fact.
I am not affiliated with Nebraska Educational Savings Trust (NEST), but I consider the NEST 529 Plan to be the “default” plan for Nebraska residents, because 1) only NEST-sponsored plans are eligible for the state income tax deduction and 2) of the NEST-sponsored plans, NEST 529 has the lowest program fees. Consider all options and consult a financial professional before investing. For more information visit Nest529.com.
A qualified tuition program, commonly known as a 529 Plan (for the section of tax code in which it is described), is a way for Americans to save for higher education. The primary feature of a 529 Plan (529) is the double-tax benefit of tax-deferred growth and tax-free withdrawals for qualified education expenses. If you believe your kids or grandkids will pursue post-secondary education (or even if not, as you’ll read below), opening and contributing to a 529 Plan can be a great gift to them.
Parties on the account
A 529 account must have an owner. Most 529 accounts are owned by an individual, but in certain circumstances can be owned by a corporation or a custodian of a UTMA/UGMA.
A 529 account must have a designated beneficiary. This is the person for whom you are saving. The account owner can change the beneficiary at any time, but to avoid taxation, the new beneficiary must be in the same family as the current beneficiary. For this purpose, NEST considers a first cousin to be a Member of the Family, as well as brothers, sisters, parents, children, etc.
“Account owners can name a new beneficiary who is a family member of the current beneficiary.”
Withdrawals
Withdrawals can be made tax-free from a 529 account for qualified expenses. Qualified expenses include (but are not limited to) tuition, fees, books, supplies and equipment required for enrollment of a Beneficiary at an eligible educational institution, including technical and trade schools.
It’s important to know, despite federal rules to the contrary, K-12 expenses (e.g. tuition at a private high school) are considered by Nebraska to be non-qualified expenses and are subject to state income tax.
Withdrawals that are not for qualified expenses are subject to taxes and a 10% penalty on the earnings portion of the withdrawal. For example, if you contribute $2,000 and the account grows to $3,000 when you withdraw the funds, you only pay taxes and penalty on the $1,000 earnings.
Rollover to Roth IRA
In 2022, Congress passed a bill that authorizes a rollover from a 529 account to a Roth IRA in the name of the beneficiary. While the rules haven’t yet been finalized, we know that the 529 account must have been open for 15 years, the existing Roth IRA rules on earned income and contribution limits still apply (though there is no MAGI phaseout), and there is a $35,000 per beneficiary lifetime limit on these rollovers.
Contributions
A 529 account can be a great Christmas gift for grandkids, or a way to save your own kids’ birthday money.
Contributions can be made electronically or by check. Once you connect your bank account to NEST, you can set up recurring contributions. You may also choose to contribute as needed. For example, whenever my girls receive cash gifts for their birthday, I make a one-time contribution for an equivalent amount.
NEST 529 has a maximum account size of $500,000 per beneficiary and applies to all accounts held by NEST for a single beneficiary, even if they have different owners.
Besides the $500,000 per beneficiary limit, there is no limit to contributions. However, because contributions are considered gifts, I often tell people to keep their contributions under the annual gift tax exclusion ($18,000 in 2024) to avoid the hassle of extra tax forms. The $18,000 per year applies to individuals, so a married couple can gift $36,000 per year to each and every person they wish.
529 accounts also have a special “front-loading” rule, in which you can contribute 5 times the gift tax exclusion ($90,000 in 2024) in year 1. This precludes you from using your annual exclusion in years 2-5 and does require IRS Form 709 to be filed.
State tax benefits
Account owners can deduct contributions made to a NEST 529 plan from state taxable income, up to $10,000 per year ($5,000 per year if Married, filing separate). Using the highest marginal tax rate in Nebraska (5.84% in 2024), this deduction can reduce your state income taxes by up to $584.
The income tax deduction also applies to funds that are rolled over from another state’s 529 plan. However, when you roll funds out of a 529 plan, you may have to pay back any state income tax benefit received by that state. Please review the rules of your existing 529 plan before rolling into a NEST plan.
Investments
Age-based portfolios are designed to be set-it and forget-it.
Before you can fund the account, you must select how it will be invested. The NEST 529 plan offers 15 mutual funds from which you can create your own custom portfolio.
If investment management is not your forte, you can also select one of three age-based index portfolios. These portfolios, as they change every 2-3 years as your beneficiary ages, move slowly from high-growth stocks to low-growth (and less volatile) fixed income funds.
Impact on financial aid
In prior years, distributions from grandparent-owned 529 accounts had negative consequences for Federal Student Aid. However, with recent changes to the FAFSA, these distributions (and any cash gift) are no longer considered. Now, grandparents can use 529 accounts to fund a grandchild’s education without impacting their federal financial aid eligibility. (While federal student aid is unaffected, there are certain schools that still consider cash gifts when doling out their own financial aid. Using this website, I did not find any such schools in Nebraska.)
“Grandparents can use 529 accounts to fund a grandchild’s education without impacting their federal financial aid eligibility.”
Parent-owned 529 plans are still considered in the Federal Student Aid formula. The Aid package may be reduced by up to 5.64% of the value of parent-owned accounts.
FAQ:
Can I use another state’s 529 plan? Yes, you can use any state’s 529 plan and still get the benefit of tax-deferred growth and tax-free withdrawals for qualified expenses. However, the $10,000 state income tax deduction is available only to contributions made to Nebraska-sponsored (NEST) plans.
What if my child/grandchild doesn’t go to college?
If the beneficiary you’ve designated does not go to college, you have three options:
You can designate another member of the beneficiary’s family (including first cousins) as a new beneficiary.
You can rollover funds into a Roth IRA in the beneficiary’s name (subject to to-date unfinalized rules).
You can withdraw the funds, paying income tax and a 10% penalty on the earnings.
Other resources:
Need help?
When you’re ready to make a financial move, please click this link to contact us.
