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Sell Tax Planning Services by Talking to Your Clients About 529 Plans

Although the pandemic has temporarily curtailed the steep rise of college tuition prices, higher education costs remain at record levels. Taxpayers continue to look for opportunities to save money on their or their children’s college experience, and your clients are likely no different. As you market your tax planning services, make sure prospects are aware of your experience with – and understanding of – 529 plans. Providing comprehensive information about these savings plans will build the trust needed to gain them as clients, and explaining how these plans can help them reach their long-term savings goals will ensure you retain them for years to come.

What are 529 Plans?

529 plans are state-sanctioned, tax-advantaged college savings plans. They were first introduced in the late 1980s, but they exploded in popularity once Congress embraced these plans at the Federal level. In 1996, with bipartisan support, Congress created Section 529 of the Internal Revenue Code.

Section 529 allows taxpayers to invest in college savings accounts for the future benefit of a single, named beneficiary. Although contributions must be made with after-tax dollars, the investment grows tax-free and can be withdrawn without paying Federal income tax, penalties, or interest if used to pay for the beneficiary’s higher education costs. Contributions to 529 plans are often deductible at the state level as well, amplifying the tax savings for plan owners.

Types of 529 Plans

All 50 states offer at least one of the following two types of plans: education savings plans and prepaid tuition plans.

Education Savings Plans

An education savings plan allows a taxpayer to invest after-tax dollars into a savings account set aside for a named beneficiary’s future qualified higher education expenses. Withdrawals can typically be used at any public or private college or university, including most trade schools, community colleges, vocational schools, and some apprenticeships. And thanks to a provision included in the Tax Cuts and Jobs Act of 2017, up to $10,000 per year can now be used to pay for elementary or secondary school tuition.

The funds are held in investment portfolios comprised of mutual funds or exchange-traded funds. The plan’s offering circular will delineate the different investment options, and the plan owner has the power to select the portfolio that is best for the beneficiary. As the beneficiary gets older, the plan owner can change their investment selection to better balance growth potential with risk.

Prepaid Tuition Plans

Owners of prepaid tuition plans purchase college credits at current rates that can be redeemed at participating universities. These plans are often seen as the less flexible of the two for a few reasons:

  1. Most prepaid tuition plans have residency requirements for the plan owner and/or the plan beneficiary while most education savings plans do not.
  2. College credits from these plans are only redeemable at participating colleges and universities. If the beneficiary attends a nonparticipating university – like one in another state – the investor might receive little or no return on their investment.
  3. Prepaid tuition plans cannot pay for elementary or secondary education costs.
  4. Prepaid tuition plans only pay for tuition, while education savings plans pay for tuition and other qualifying education expenses.

Qualifying Education Expenses

Withdrawals from 529 plans are free from Federal income tax if those withdrawals are used to pay for qualifying education expenses. Withdrawals from education savings plans can be used to pay for the following higher education expenses:

  • Tuition
  • Room and board, including off-campus housing
  • Mandatory fees
  • Books
  • Supplies
  • Approved study equipment

Beginning in 2018, withdrawals can also be used to pay off student loans – with limitations. In a lifetime, the account owner can direct $10,000 to pay down the beneficiary’s student loans plus $10,000 to pay down the student loan balances of the beneficiary’s siblings. This means that an account owner with three children can withdraw a maximum of $30,000 from their plan to pay for their children’s student loans.

Other Common Questions

529 plans are simple to establish and maintain, but account owners should understand the plan’s capabilities and limitations before they jump in. This is where you can sell your tax planning services. Familiarize yourself with these common questions so that you are prepared when prospects or clients ask for more information about 529 plans.

  • Who can open a 529 plan? Any individual taxpayer can open a 529 plan. Most often, parents open 529 plans for their children, but individuals can open 529 plans for any beneficiary they choose – a grandchild, a niece or nephew, a friend, a friend’s child, or even themselves.
  • Can 529 plans have more than one beneficiary? No. However, plan owners can change the beneficiary if they so choose. There are no tax consequences to change the beneficiary, but it can only be changed to a family member of the current beneficiary (sibling, niece, nephew, parent, in-law, child, cousin, etc.). This allows families with multiple children to use a single 529 plan to pay for college. Once one child has attended university, the parents change the beneficiary to the next oldest child, and so-on.
  • What are the contribution limits? Few states impose annual contribution limits on 529 plans, but there is a catch: 529 plan contributions are subject to gift taxes. To keep 529 plan contributions free from gift tax treatment, your clients must keep their contributions below the annual gift tax exclusion of $15,000 per year per beneficiary ($30,000 for married couples). There are even opportunities to make advanced contributions of up to five years of the gift tax exclusion in one year. For 2020, that would be $75,000 ($15,000 x 5). Of course, they cannot then use the gift tax exemption for the same beneficiary for the next five years.
  • Are there state tax benefits? Some states encourage their residents to invest in their plan by offering tax incentives to do so. New York, for example, will give New York filers a tax deduction for all contributions they make to a New York 529 plan. Not all states offer this option, so you may need to do some research for your clients if they are seeking a state tax benefit.
  • Do 529 plan withdrawals need to be paid directly to the university? No. 529 plan withdrawals can be paid directly to the education institution or can be treated as reimbursements.

Now of course, 529 plans are not the only options taxpayers have to save for college. They may also establish a trust, open a Coverdell Education Savings Account, or simply invest directly into mutual funds. But 529 plans offer unique tax saving opportunities that many of the alternatives do not. Your knowledge about these plans can help you attract prospects, or it may help you sell tax planning services to existing clients. At Corvee, we have a robust tax planning software that can help you find many more tax savings strategies beyond 529 plans for each of your clients. In fact, you can make multi-entity, multi-year tax plans across thousands of strategy combinations. Reach out to us today if you sell tax planning services and request a demo.

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