MILLIONS OF AMERICANS USE 529 college savings plans to sock away money for their kids’ and grandkids’ education. They’re popular, in part, because of the tax benefits they can provide: withdrawals, including any earnings, aren’t taxed by the IRS when they’re used for qualified college expenses. (For details, see IRS Publication 970.*) Beginning in 2015, the IRS adopted several rule changes that give savers more flexibility in how their 529 accounts can be used, according to Richard Polimeni, director of Education Savings Programs at Bank of America Merrill Lynch. Here’s a quick rundown of what’s changed:
✔ Tech gets a free pass. Computer equipment and services, including software purchases and Internet access, qualify as allowable education expenses. Under the old rules, withdrawals to cover tech purchases were considered eligible only if the school required them.
“With their generous tax benefits and flexibility, 529 plans have always been a great way to invest for higher education.”— Richard PolimeniDirector of Education Savings Programs, Bank of America Merrill Lynch
✔ You can redeposit tuition refunds. Say you get a tuition refund after dropping a class. Now that refund can be reinvested in the 529 account from which it was originally withdrawn without paying a tax penalty, as long as it’s redeposited within 60 days of the date it was issued. Under the old rules, unless there were other eligible expenses the refund amount could be applied to, the IRS would have considered it taxable income.
✔ Potential penalties have eased. Previously, if someone with multiple 529 accounts withdrew funds from one of them to pay for an expense the IRS considered unqualified, a penalty would be charged, based on a percentage of the earnings held in all accounts. Under the new rules, penalties are assessed only against the account from which the funds are drawn—which could mean a lower penalty for you.
“Because of their generous tax benefits and flexibility, 529 plans have always been a great way to invest for higher education,” says Polimeni. “With the federal rule changes, they are that much more attractive.”
3 Questions to Ask Your Advisor
- What are some alternative ways to save for my kids’ college?
- Can I use a 529 college savings plan to pay for my own education?
- With so many different 529 plans available, how can I decide which one is best suited to my family’s needs?
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*To be eligible for the favorable tax treatment afforded to any earnings portion of withdrawals for Section 529 accounts, withdrawals must be for “qualified higher education expenses,” as defined in the Internal Revenue Code. If the funds are not used to pay for qualified higher education expenses, any earnings are subject to income tax and an additional 10% federal tax, and may also be subject to state and local income taxes.
Before you invest in a Section 529 plan, request the plan’s official statement from your
Merrill Lynch financial 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 against creditors that are available only for investments in such state’s 529 plan. Section 529 plans are not guaranteed by any state or federal agency.