Which States Reward 529 Plan Savings? March 10, 2017 Adviser Fund Update Print Which States Reward College Savers? Our last Adviser Fund Update focused on the basics of 529 plans. In this edition, we’ll continue examining 529s with a look at tax implications, riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. strategies and the implications on financial aid eligibility. 529 Tax Implications Contributions to 529 plans are not tax deductible (at the federal level, treatment varies at the state level), though earnings made in the plans are not subject to income taxes when used properly. Account owners can make annual gifts of up to $14,000 for single tax filers and $28,000 for those filing jointly to a beneficiary without exceeding the annual federal gift tax limit. 529s can work well as wealth transfer and estate planning vehicles. You can make a one-time contribution of up to $70,000 ($140,000 if married filing jointly) for a beneficiary and choose to treat the deposit as if it was made over a five-year period for gift tax purposes. For people who have been advised to reduce their estate tax exposure, this is a way to “gift” your assets without giving them up completely; make yourself the account’s beneficiary and its value comes back to your estate (with some strings attached for non-qualified distributions, however). Withdrawals also can have tax implications. Even if you know the exact amount of tuition you want to withdraw, make sure to subtract any grants or scholarships. Why? Because taking out more money than you need for education-related expenses can lead to paying federal income tax and a 10% penalty on the difference between qualified and non-qualified distributions. Currently, 28 states and the District of Columbia offer a tax credit or deduction for contributions to their state’s 529 plans (Massachusetts recently added a deduction, while Maine discontinued its deduction at the end of 2015). If you live in one of these states, there could be a strong incentive to invest at home (see second table below for tax-year 2017 deductions). Arizona, Kansas, Missouri, Montana and Pennsylvania offer tax parity, meaning you can invest in any state’s plan and get that state’s tax benefits. Tax Parity States State Maximum Annual 529 Deduction Arizona $2,000 single or head of household/$4,000 joint Kansas $3,000 single/$6,000 joint per beneficiary Missouri $8,000 single/$16,000 joint Montana $3,000 single/$6,000 joint Pennsylvania $14,000 single/$28,000 joint per beneficiary Source: Savingforcollege.com. State Tax Deductions (for contributions to in-state plans) State Maximum Annual 529 Deduction Alabama $5,000 single/$10,000 joint Arkansas $5,000 single/$10,000 joint Colorado Full contribution amount up to contributor’s adjusted gross income Connecticut $5,000 single/$10,000 joint, five-year carry forward of excess contributions District of Columbia $4,000 single/$8,000 joint, five-year carry forward of excess contributions Georgia $2,000 single/$4,000 joint per beneficiary per tax return Idaho $4,000 single/$8,000 joint Illinois $10,000 single/$20,000 joint Indiana 20% tax credit on contributions up to $5,000 Iowa $3,239 single/$6,478 joint per beneficiary (adjusted annually for inflation) Louisiana $2,400 single/$4,800 joint per beneficiary, unlimited carry forward of excess contributions Maryland $2,500 per beneficiary per year, 10-year carry forward of excess contributions Massachusetts $1,000 single/$2,000 joint Michigan $5,000 single/$10,000 joint Mississippi $10,000 single/$20,000 joint Nebraska $10,000 per tax return; $5,000 if married filing separately New Mexico Full amount of contribution New York $5,000 single/$10,000 joint North Dakota $5,000 single/$10,000 joint Ohio $2,000 per beneficiary, unlimited carry forward of excess contributions Oklahoma $10,000 single/$20,000 joint, five-year carry forward of excess contributions Oregon $2,330 single/$4,660 joint, four-year carry forward of excess contributions Rhode Island $500 single/$1,000 joint, unlimited carry forward of excess contributions South Carolina Full amount of contribution, including rolloverThe process of transferring funds from one retirement account to another, typically without incurring a tax. contributions Utah 5% tax credit on contributions up to $1,920 per beneficiary for single filers or $3,840 per beneficiary for joint filers (maximum credit $96/$192) Vermont 10% tax credit on up to $2,500 in contributions single/$5,000 joint (maximum credit $250/$500) Virginia $4,000 per account per year (fully deductible age 70 and older), unlimited carry forward of excess contributions West Virginia Full amount of contribution Wisconsin $3,100 per beneficiary; $1,550 if married filing separately Source: Savingforcollege.com. No State-Specific Benefits No State Tax Deduction No State Income Tax California Alaska Delaware Florida Hawaii Nevada Kentucky New Hampshire Minnesota South Dakota New Jersey Tennessee North Carolina Texas — Washington — Wyoming Source: Savingforcollege.com. Managing Your 529 Plan As many investors scale back their stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. allocation and opt for more bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. investments on the approach to and beginning of retirement, a similar strategy can be used with 529s. If you begin investing when your beneficiary is an infant, with an 18-year time horizon, it may make sense to direct the 529’s investments more towards stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company., which generally have better long-term growth potential than bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. or cash. Once college expenses come closer, you might feel that bonds or cash are more appropriate to protect your earnings and make sure that you are insulated against market declines now that you actually need the money. Under current tax law, you can reallocate your account twice a year, and you can change how future contributions are allocated as often as you like. (Speaking of retirement, parents need to consider their own priorities if weighing the decision to only fund their own retirement portfolio or a child’s 529 fund. After all, your child can always borrow money for college. You can’t borrow money for retirement.) Other college savers can opt for age-based 529 plans to avoid the legwork of shifting allocations. Vanguard, for example, offers a questionnaire for parents to determine their risk toleranceThe amount of loss an investor is willing to absorb in their investment portfolio.. Once set on a conservative, moderate or aggressive course, Vanguard will automatically adjust the asset allocation over time, gradually shifting from stocks to bonds as college age approaches. Many other plans share similar risk or age-based tracks for more hands-off investors. Financial Aid Implications The College Cost Reduction and Access Act of 2007 (CCRAA) enacted legislation to treat assets held in 529 prepaid tuition plans and college savings plans as parental assets (rather than as belonging to the student), and thus generally have little impact on a student’s federal financial aid eligibility. Savings in 529 funds are reported on the student’s Free Application for Financial Aid (FAFSA) as parental assets, which are currently assessed at 5.64%. For example, under the CCRAA, if a student’s parents have $25,000 in a 529 plan, only $1,410 will be considered the student’s “Expected Family Contribution.” Let’s walk through an example, assuming you file the FAFSA paperwork when your child is a high school senior. You have a 529 account with $100,000 in it, of which $50,000 was your initial contribution and $50,000 is earnings. In the first year, your child’s eligibility for federal financial aid will decrease by no more than 5.64% of the account value, or $5,640. Assuming the account value stays the same over the course of the year and you withdraw $20,000 to pay for freshman year education expenses, when you apply for sophomore year aid, your account value is now $80,000, which is again assessed at 5.64%, or $4,512. The $20,000 withdrawal included $10,000 of excluded earnings with it, but none of the withdrawal is counted as financial aid income. There are a few things to be aware of if you’re a grandparent or not the legal guardian of your chosen beneficiary when it comes to the impact of withdrawals from your plan on a student’s eligibility for need-based financial aid. True, the value of 529 plan assets owned by a grandparent (or any non-guardian) is not reportable on the FAFSA application. However, precisely because grandparent-owned 529s do not have to be reported as an asset on FAFSA form, any distributions from those 529s are considered untaxed student income on a future year’s FAFSA. Any financial support given to a student from their grandparents, even 529 distributions, counts as untaxed income and is reportable on the FAFSA as student income. However, under new rules announced in late 2015 and going into effect for the 2017–2018 academic year, 529 plan distributions would be reported as student income two years after those funds were used for qualified purchases. The student’s FAFSA for her senior year will reflect the income received when she was a sophomore under the new rules, rather than that from her junior year. So the savvy grandparent might wait to use the 529 account to pay for junior and senior years of college, when the student will not need to worry about applying for financial aid again (unless they plan to receive aid for graduate school within the next two years). Grandparents can also transfer the account to a parent, so the 529 counts as parental assets, as seen above. Finally, grandparents can wait until the student has graduated and take a non-qualified distribution (perhaps to pay off student loans). While you’ll pay income taxes and a penalty on the earnings of non-qualified distributions, those hits can be less costly than losing eligibility as a result of untaxed income going to the student via 529 distributions. Notable 529 Plans In an upcoming Adviser Fund Update, we’ll conclude our series on 529s with an in-depth look under the hood of several popular plans, including Virginia’s 529Invest, T. Rowe Price College Savings Plan, Vanguard 529 College Savings Plan and the Utah Educational Savings Plan. We’ll also give our take on Fidelity’s 529 plan options. About Adviser Investments Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). 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