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Three Tax Improvements to 529 College Savings Plans
College savings plans, also known as Section 529 plans, have become a popular tool for parents and grandparents to invest funds for a youngster’s higher education costs. These plans are state-sponsored, with each state pairing up with one or more financial institutions to offer the investment alternatives. The primary feature is that the investments grow tax-free and can be extracted tax-free if spent for the beneficiary’s higher education costs.
In tax legislation enacted late in 2015, Congress made three improvements to the rules governing 529 plans. All three affect disbursements during college years.
529 computer and technology rules eased
The legislation expands the definition of qualified higher education expenses to include computer or peripheral equipment, software, and internet access if it is used primarily by the beneficiary during higher education years. Previously, computer and technology expenses were only qualified for tax-free 529 plan reimbursement if the technology was required for enrollment or attendance at the school.
No distribution aggregation for multiple accounts
Many students approach college with multiple 529 accounts because parents and grandparents often separately establish these plans. In the past, all 529 plans were aggregated as if they were one account for the purpose of determining the amount of income associated with a distribution not properly expended on higher education costs. But this aggregation rule has been repealed — meaning that a withdrawal from a particular 529 account with no earnings does not create taxable income — even if that withdrawal is not used for qualified higher education costs.
If a student has more funds in various 529 accounts than required for higher education costs, there is an obvious strategic maneuver: The college costs should be covered by those 529 accounts with the highest appreciation or earnings, so that the excess withdrawals are taken from the low gain accounts. Or if a nonqualified expenditure will be made, such as for a vehicle for the student, look for the account with the smallest gain.
School refunds can be recontributed into 529 plans
In some cases, after tuition and other higher education costs are paid using a 529 account, the student may receive a refund from the school. For example, assume a student wins a last-minute scholarship that is paid directly to the school, and as a result the school reimburses previously paid tuition. Or perhaps the student drops a class and receives a tuition refund. In the past, if that tuition had been paid with a 529 account, the effect was that an excess distribution occurred because a 529 withdrawal was not fully consumed by college costs. The tax law now allows the family to recontribute the tuition reimbursement back into the 529 plan within 60 days of receipt to avoid any taxable distribution.
How we can help
These three enhancements make 529 plans even more attractive than in the past. If paying for a family member’s college expenses is a goal, it’s important to include it in your overall financial plan. Your tax advisor can help you make choices that are in the best interest of you and your student.