New rules can make it easier for you to handle education costs using the funds you’ve accumulated
529 ACCOUNTS HAVE LONG BEEN A POPULAR WAY to set aside funds for education. They allow you to stash away money regularly while your son, daughter or other beneficiary is young and when they’re ready, the assets can be withdrawn tax-free—as long as you use them to pay for “qualified higher education expenses1.”
“Tuition and fees are the biggest educational bills you'll probably face, but there are other eligible expenses,” says Richard J. Polimeni, head of Education Savings Programs for Bank of America. Room and board, books, computers and peripheral equipment, computer software, internet access and related services and required supplies are among the expenses that qualify. If your beneficiary is a special-needs student, certain other expenses may also qualify. The Internal Revenue Code spells it all out.
“Tuition and fees are the biggest educational bills you'll probably face, but there are other eligible expenses.”—Richard J. Polimeni, head of Education Savings Programs for Bank of America.
And recently, the list of what’s considered “qualified” has grown. 2019’s SECURE Act expanded what can be treated as qualified higher education expenses to include the cost of required fees, books, supplies and equipment for a designated beneficiary in a registered and certified apprenticeship program. The act also allows you to use your 529 account to pay interest of principal on qualified education loans up to a lifetime maximum of $10,000 for a designated beneficiary or a sibling of the designated beneficiary. (The lifetime maximum is applied separately for the sibling’s loans and the designated beneficiary’s loans.1 And state tax treatment of these expenses may vary.)
You can even use your 529 assets to help pay tuition at an elementary or secondary public, private or religious school, thanks to the SECURE Act. You’re limited to a federal tax-free distribution of up to $10,000 per calendar year per beneficiary, for all 529 accounts for that beneficiary. (Again, state tax treatment may vary.)
While 529 accounts offer plenty of flexibility in uses, here’s an example of where you might run into problems if you try to test the limits of what "qualified higher education expenses" means. “Using 529 account funds in an account with your daughter as the designated beneficiary, you could pay for tuition at an accredited institution for her to get a music degree,” Polimeni says. “But if you use those funds to pay for private piano lessons, you’ll have to pay income tax as well as a 10% additional federal tax on the earnings portion of the money you withdraw.” You will never pay income tax or the additional federal tax on the principal portion of your withdrawal, regardless of what it is used for.
If there’s something left over in a child’s 529 account, it may be able to stay in the account indefinitely—and, decades later, be rolled over to help pay the cost of a grandchild’s education.
The rules are flexible when it comes to how many students can benefit from a single 529 account. Suppose you set aside $200,000 in an account with your daughter as the designated beneficiary, and you spend only half of the money. You could transfer the rest to a 529 account for certain other members of your family, including your son or even a niece or nephew. If there’s something left over, it may be able to stay in the account indefinitely—and, decades later, be rolled over to help pay the cost of a grandchild’s education. Or it could even be used to fund your own or your spouse’s continuing education. Consult a tax advisor about the tax implications of rolling over a 529 account.
Beyond 529s: Another Way to Save for Education
If you want to set aside money for lessons or other educational activities that a 529 account doesn’t cover, you could consider a trust or a custodial account under the Uniform Gifts/Transfer to Minors Act (UGMA/UTMA). “However, there are potential drawbacks to that strategy,” Polimeni notes. “These gifts can’t be taken back and you can’t transfer assets between beneficiaries. What’s more, once the child you designate as beneficiary reaches a certain age—which varies by state—he or she will be free to spend the money for purposes other than education. If that’s a concern, you may decide you’re better off using a typical savings account to earmark money for educational goals that a 529 account doesn’t cover. Also, any gifts made to a UGMA/UTMA or a 529 could count against your federal gift tax annual exemption, so you should coordinate your gifts appropriately. Your financial advisor can help you figure out what makes the most sense for your family.
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Before you invest in a Section 529 plan, request the plan’s official statement from your Merrill Lynch Wealth Management Advisor and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection from creditors that are only available for investments in such state’s 529 plan.
¹To be eligible for favorable tax treatment afforded to the earnings portion of a withdrawal from a Section 529 account, such withdrawal must be used for “qualified higher education expenses,” as defined in the Internal Revenue Code. The earnings portion of a withdraw that is not used for such expenses is subject to federal income tax and may be subject to a 10% additional federal tax, as well as applicable state and local income taxes. The additional tax is waived under certain circumstances. The beneficiary must be attending an eligible educational institution at least half time for room and board to be considered a qualified higher education expense, subject to limitations. Institutions must be eligible to participate in federal student financial aid programs. Some foreign institutions are eligible. You can also take a federal income tax-free distribution from a 529 account of up to $10,000 per calendar year per beneficiary from all 529 accounts to help pay for tuition at an elementary or secondary public, private or religious school. For distributions taken after December 31, 2018, qualified higher education expenses now include expenses for fees, books, supplies, and equipment required for the participation of a designated beneficiary in an apprenticeship program registered and certified with the Secretary of Labor under the National Apprenticeship Act and amounts paid as principal or interest on any qualified education loans of the designated beneficiary or sibling of the designated beneficiary, up to a lifetime maximum of $10,000 per individual. Distributions with respect to the loans of a sibling of the designated beneficiary will count towards the lifetime limit of the sibling, not the designated beneficiary. Such repayments may impact student loan interest deductibility. State tax treatment may vary for distributions to pay for tuition in connection with enrollment or attendance at an elementary or secondary public, private or religious school, apprenticeship expenses, and payment of qualified education loans.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions