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Section 529 Plans - A Covid Inspired Refresher Thumbnail

Section 529 Plans - A Covid Inspired Refresher

Section 529 plans – A Covid-19 Inspired Refresher

One of the great aspects of living in Chapel Hill, is that we get to interact with students on a regular basis.  With Covid-19 severely curtailing the College experience, and bringing up the possibility of online classes, many are considering taking a GAP year.

The idea of a GAP year has led to discussions around how this might affect the use of 529 accounts.  Would there be any negative financial consequences for a 529 Account owner?   Or the student beneficiary?  Let’s refresh things.

Overview of 529 Plans:

In a nutshell, a 529 plan is a savings vehicle that provides a variety of tax breaks for savers who intend to use the funds to help offset education costs.

Although 2 types of 529 plans exist - Prepaid Tuition Plans and Savings Plans - we will focus on the better-known Savings Plans.

The Tax Breaks:

  • Potentially a State Income Tax deduction on contributions.   Unfortunately, no State Income tax deduction for residents of North Carolina.  (There is no Federal Income Tax deduction for contributions to a 529 plan.) 
  • Deferred taxes on the earnings in the 529 Account.  If you held assets outside a 529 plan in a taxable account, every time you sold a security, you would trigger a tax event.  Not so for assets in a 529 plan. 
  • Tax-Free Withdrawals of earnings. If the earnings/growth are used for “Qualified Education Expenses” you do not have to pay any federal or state taxes on these amounts.  (Your contributions are not taxed either as they were made with after-tax funds.)

What Qualifies as a “Qualified Education Expense"?

Common expenses such as:

  • Tuition for University, College, Trade School, Vocational School and Apprentice Programs.
  • Room & Board, as well as fees, books, supplies, equipment, computer hardware/software, and internet access.

Lessor known qualified expenses:

  • $10K per beneficiary Lifetime Student Loan repayment.
  • $10k per year per beneficiary of Public, Private and Religious school fees for students in Kindergarten through 12th Grades.   This benefit is relatively new.

Additional Benefits:

Great Flexibility in naming of beneficiaries.  If you switch the beneficiary to a “Qualified Family Member”, the beneficiary can be changed without losing the tax benefits outlined above.

Bundling of 5 years Gift Tax Exclusion benefits.  Normally, contributors want to stay below the Annual Gift Tax Exclusion Limit.  In 2020, this is $15k per donor per beneficiary per year.  So, if bundling, 2 parents together can contribute up to $150k to each 529 plan and not run afoul of Annual Gift Tax rules.  Very nice if you have funds like this hanging around.

Control of the funds always rests with the 529 account owner.   Even when the beneficiary reaches the age of majority, the 529 plan remains in the control of the owner.

The Potential Downside:

If you cannot find a deserving beneficiary or need to withdraw funds from a 529 plan for a reason that is not a “Qualified Education Expense.”  You get negatively impacted in 2 ways:

  • Ordinary tax rates apply to any earnings. (No Capital Gains Tax treatment)
  • A 10% penalty is also applied to these earnings.

So, in almost all cases, there would not be any negative impacts of taking a GAP year from a 529 account perspective.  The account owner will just hold the assets longer and let them grow a little larger.  If or when the student undertakes more studies, the funds can be used as long as they meet the conditions outlined above.

The 529 plan is a great savings vehicle for most savers preparing to help meet future education costs………even if Covid-19 inspires a GAP year!


This is being provided for informational purposes only and should not be construed as a recommendation to buy or sell any specific securities. The views expressed are those of Southern Investment Management Collective (SIMC) and do not necessarily reflect the views of Mutual Advisors, LLC or any of its affiliates. SIMC, nor any of its members, are tax accountants or legal attorneys, and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional. Investment advisory services offered through Mutual Advisors, LLC DBA Southern Investment Management Collective, a SEC registered investment adviser.


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Description automatically generatedAbout the Author:  Kent Fisher, CFA, CFP®

Kent Fisher is a Chapel Hill, NC Fee-Only Comprehensive Wealth Manager at the Southern Investment Management Collective (SIMC).  SIMC provides comprehensive financial planning, retirement planning and investment management services to help clients organize, grow and protect their assets.  SIMC serves clients as a fiduciary, and tailors all solutions to each client's unique situation