College Planning

January 21, 2016 / Peter A. Scilovati

529 College Savings Plan 2016…What has Changed?

Parents looking to save for college have long turned to 529 college savings plans as a tax-advantaged way to put away money for higher education. According to Sallie Mae’s 2015 How America Saves for College survey, while 89% of parents believe college is an investment in their child’s future, only 27% of savers are using a 529 college savings plan. What’s more, 48% use a traditional savings account, despite the low yield on this type of savings vehicle in today’s current interest rate environment.  529 plans are attractive because parents can invest money in the stock market and, hopefully, grow their savings without facing a taxable event when they use the money for qualified higher education expenses such as tuition, books and room and board.

One of the biggest and most helpful changes to 529 plans for this year is what can now be deducted as a college expense. According to Rick Castellano, a spokesman at Sallie Mae, in the past, parents weren’t able to deduct computers, tablets and other electronic devices as a qualified education expense, but now they can. When the rules were passed for 529s back some twenty years ago, computer equipment wasn’t found in every classroom and attached to every college student’s hip. Now, it’s almost a requirement on college campuses around the country.

In addition to giving families greater flexibility in terms of what their 529 savings can get them, the government has made it easier for students to take off from school without being penalized. Up until Jan. 1, students who used money from a 529 college savings plan and for whatever reason had to drop out of school with a full refund weren’t allowed to redeposit the money into the 529 savings plan. That meant that if an illness, family emergency or other circumstance prevented the student from attending college, the money that initially went to pay for college would be treated as income and taxed accordingly. “529s treated it as once you get the money, it is a distribution and is a completed transaction,” says Betty Lochner, chair of the College Savings Plans Network. That all changes this year. Now, students who have to withdraw from college for whatever reason and get their tuition back can reinvest it into the 529 account and avoid a tax bill.

A third change in 2016 is that grandparent-owned 529 plans can now be used to fund the final two years of college–not just the final year–with no detrimental impact on the grandchild’s financial aid package.

529 plans–technically known as “Qualified Tuition Programs” under Section 529 of the Internal Revenue Code—were often an inefficient way for grandparents to help finance a grandchild’s college tuition. That is because unlike a parent’s contribution to a 529 plan, a grandparent’s contribution (or any other non-parent for that matter) to a 529 plan could greatly reduce the amount of financial aid a child was potentially eligible for. Here’s why:

On the Free Application for Federal Student Aid (FAFSA), 50% of withdrawals from a grandparent-owned 529 plan that were used to pay for a student’s schooling were essentially included as the student’s income. As a result, this hurt the student’s ability to maximize their financial aid. By comparison, withdrawals from a parent-owned 529 plan added only up to 5.64% to the amount of the student’s income (referred to as Expected Family Contribution, or EFC) on the FAFSA.

But thanks to a recent law change, 529s are now a more attractive option for grandparents who are looking to help finance the younger generation’s sky-high college costs.  As summarized in a recent Forbes article, “the FAFSA for the 2017-2018 academic year will look to student and parent income from the 2015 calendar year, as opposed to the 2016 calendar year.”

Well before the recent tax change, the best way for a student to use a grandparent-owned 529 plan AND still qualify for the maximum amount of financial aid, was to use grandparent funds in the student’s final year of college only. Why? Because the FAFSA looked at prior year income when determining financial aid for the current year.  If funds were used before the final year of college, then 50% of the amount withdrawn was added to the student’s EFC. That often resulted in a potentially significant reduction in financial aid.

But now, students can use the funds in a grandparent-owned 529 plan for the final two years of college—not just the last year–with no detrimental effect on their financial aid eligibility. This is because withdrawals from grandparent-owned 529 plans are considered income to the student when calculating financial aid for the next school year.  But if the FAFSA is now only looking at income from two years ago, a student can withdrawal from a 529 plan in their final two years of college without any effect on financial aid.  The change essentially doubles the impact of grandparent contributions.

Looking out to beyond 2016, experts say more changes could be coming to 529 plans that will benefit savers even more. Lochner says the College Savings Plan Network is working on a tax savers credit in which 529 accounts would be treated as retirement accounts in which an employer can match contributions. In the case of 529, up to $600 would be matched and not taxed. While that didn’t make it into the recent legislation, Lochner says it was mostly a technical issue, not a cost one. “We’re working on improving the plan any way we can,” she says.

Sources:

GoodCall, LLC

Sallie Mae

College Savings Plan Network

 

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