My child just got a full scholarship- what about my 529 Plan?
Since your child has received a full scholarship, you can withdraw--without penalty--some of the funds in your 529 account. In each withdrawal from your 529 plan, you receive some earnings and some of the contributions that were made to the account. Generally, a penalty is imposed on the earnings portion of each withdrawal that you don't use to pay qualified higher education expenses. Your child's scholarship creates an exception. As long as your withdrawals during the year don't exceed the amount of the scholarship for the year, you will not owe a penalty.
Keep in mind that you may owe federal, and in some cases, state income taxes on the earnings portion of each withdrawal. However, you won't owe federal income taxes if your withdrawals during the year don't exceed the amount of your child's scholarship for the year.
Withdrawing the funds isn't your only option. You can leave the funds in the 529 account for your child's future use (some plans allow 529 funds to be used for graduate school). Or, you can change the beneficiary of the 529 account. If the new beneficiary and your child are members of the same family, you won't owe federal income taxes or a penalty when you make the change. But the change of beneficiary could cause a gift tax or a generation-skipping transfer tax, so pick the new beneficiary with care.
Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.
If I Open a 529 plan for my grandchild, will it be subject to Medicare Spendown if I need long term care?
Very possibly. So far, state laws have largely ignored this issue. But unless future legislation in your state exempts 529 plans from Medicaid rules, you'd be wise to assume that these assets will be subject to the state's grasp.
To be eligible for Medicaid, most states require that your assets and monthly income fall below certain limits. A state may count the assets and income that are legally available to you for paying bills. You can make assets unavailable by giving them away or by holding them in certain trusts. In some cases, though, such transfers may create a period of ineligibility before you can collect Medicaid.
The potential problem with 529 plans is that your contributions are "revocable." This means that you can contribute money to your grandchild's 529 account today, and then take it back (subject to income taxes and a penalty) later. Since it's possible for you to get your hands on the money, your state Medicaid authorities may consider your 529 gift to be a countable asset when considering your eligibility for Medicaid. That might prevent or delay your eligibility for Medicaid.
In addition, your state has the right to "look back" at your finances 60 months from the date you apply for Medicaid. Contributions you've made to your grandchild's 529 account within this period may delay your eligibility for Medicaid.
You may want to consult a Medicaid planning attorney and keep abreast of changes in your state's laws with respect to Medicaid and 529 plans.
Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about 529 plans is available in each issuer's official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits.
529 Plans: Questions Answered
529 College Savings Plans
If you find yourself intimidated by the ever-rising price of higher education, then a 529 college savings plan might be a key component in saving for a college education. A 529 college savings plan is a tax-advantaged way to save for college and pay for higher education expenses. Unlike some other savings vehicles, a 529 college savings plan may allow you to make sizeable contributions. The funds may generally be used for any qualified college or higher education expense, including tuition, room, board, fees, books, supplies, and equipment. Tax benefits may be subject to certain restrictions.
Money in a 529 college savings plan grows tax deferred. And you may be able to withdraw the money without having to pay federal and state income taxes—depending on the plan and where you live—as long as it's used to pay for qualified, higher-education expenses. 1 If the money from 529 college savings plans is used for other purposes, the earnings portion of a withdrawal is subject to ordinary federal income tax, an additional 10% federal tax, and any applicable state income taxes. 529 college savings plans may also affect a student's eligibility for financial aid.
Types of 529 Plans
Although many details of 529 college savings plans vary by state, they generally come in two forms:
- College savings plans—allow you to invest your money in an account to pay for the student's higher education expenses. Students can use the funds for qualified expenses at accredited institutions in the U.S. and abroad.
- Prepaid tuition plans—allow you to lock in tuition rates at eligible colleges or universities with a lump-sum investment or monthly payments. In other words, since you are paying in advance, you are avoiding potential tuition inflation down the road.
Gift Tax and Estate Tax Benefits
529 plans are partially exempt from the gift tax. You can contribute up to $14,000 ($28,000 for married couples) annually2 per beneficiary, or up to $70,000 ($140,000 for married couples) over a five-year period, without triggering the gift tax.3
Keep in mind that your gifts are excluded from your estate, so investing in a 529 Plan can be a smart strategy to reduce your estate tax.
Scholarship Withdrawals
Funds may be withdrawn without penalty if the beneficiary receives a scholarship (withdrawals can be made up to the scholarship amount), or in the event of the death or disability of the beneficiary. Ordinary federal and state income taxes would be owed on any investment earnings included in gross income.
1 A federal 10% penalty may be imposed on the earnings portion of a non-qualified withdrawal in addition to ordinary income tax.
2 Annual exemption amounts are subject to revision by the Internal Revenue Service.
3 If the Account Owner utilizes the special five-year lump sum exclusion and dies within five years of the funding date, the portion of the contribution allocable to the years remaining in the five-year period (beginning with the year after the Account Owner's death) would be included in the account owner's estate for Federal estate tax purposes. Clients should consult their tax advisor.
Investments in 529 college savings plans are not deposits or obligations of any bank, are not guaranteed by any bank, are not insured by the FDIC or any other agency, and involve investment risks, including the possible loss of the principal amount invested.
Conditions, such as contribution limits, vary by plan. 529 college savings plans are subject to market risk and volatility. Accounts may lose or gain value. Diversification does not assure a profit or protect against loss
Before investing in any plan, investors should carefully consider investment objectives, risks, charges and expenses. Plan disclosure documents contain this and other information about the plans, and may be obtained by asking your financial advisor. Read these documents carefully before investing
Some states offer favorable tax treatment to their residents only if they invest in the state's own plan. You should consult your tax advisor.
The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. We are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel.
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