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Making the most of your 529 plan

Key takeaways

  • Beginning in the 2024–2025 academic year, grandparent-owned 529 plans will not be considered to be student income.
  • It's possible to make up to 5 years of annual gifts to a 529 all at once.
  • Depending on the circumstances, an irrevocable trust may be able to open and own a 529 plan, potentially reducing exposure to taxes.
  • The SECURE 2.0 Act provides a new option for withdrawing 529 funds penalty-free.

While 529 plans may seem relatively simple on the surface, there are some important nuances to consider if you want to make sure you're getting the most out of your contributions. Legislative changes have opened up new opportunities, and some lesser-known techniques may be able to help you enhance your growth potential and save more on taxes.

Good news for students with generous grandparents

Traditionally, distributions from grandparent-owned 529 plans were considered student income, which could lead to a reduction in the amount of financial aid a student would receive. Starting in the 2024–2025 academic year, however, the Free Application for Federal Student Aid (FAFSA) will no longer consider such distributions to be student income. This change will eliminate what has long been known as the "grandparent trap," and means that grandparents can feel free to assist with education funding without having to worry that their help might have an adverse effect on their grandchild's application for federal financial aid.

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Accelerated gifting with your 529

Unlike a payment made directly to an educational institution, a contribution to a 529 plan is considered a taxable gift—unless, that is, the amount contributed is lower than the annual gift exclusion. In 2024, that amount is $18,000 for an individual, or $36,000 for a married couple splitting the gift.

However, there is a unique feature of 529 plans that would allow contributions made in a single year to be spread out over 5 years for gift tax purposes. Known as "accelerated gifting,"* this allows particularly generous parents or grandparents to deposit a substantial amount of money all at once, giving the funds a greater opportunity to grow over time.

In fact, the parents or grandparents could time their contributions in such a way that allows them to give as much as possible without triggering a taxable gift. For example, 2 parents or 2 grandparents could max out their annual gift exclusion in December, contributing $36,000 to the 529 account, then, when they're free to give again in January, make 5 years' worth of accelerated gifts—an additional $180,000.

To make sure this is all captured appropriately by the tax authorities, the parents or grandparents would need to file a gift tax return and specifically elect to take the 5-year treatment. It's a good idea to consult with a tax professional to ensure this is done correctly. Additionally, in order for the gift to be fully excluded from their estates, the parents or grandparents need to survive beyond the 5-year period. (The gift is excluded from the giver's estate over time, 20% each year.)

One important thing to remember: Accelerated gifting in this manner would mean that any subsequent gifts given to the beneficiary of the 529 would either result in taxable gifts or reduce your lifetime gift exemption amount.

529s in trusts

If you've established an irrevocable trust with the intention of using trust assets to help fund a child or grandchild's education, you may want to explore whether or not the trust is able to establish and own the 529 itself. That way, educational payments could be made from the 529, rather than from the trust directly.

How does this help? Mainly by reducing your exposure to taxes. Irrevocable trusts are taxed aggressively; the highest marginal tax rate on income kicks in at $15,201 (in 2024), which means even relatively low rates of trust income will have a big chunk taken out of them by taxes. By placing trust assets into a 529, they can grow and earn income unencumbered by the tax treatment of the trust.

That said, this may not be possible depending on how the irrevocable trust is designed or the laws of the state in which it is based. Those interested in this strategy should consult with an attorney to ensure it's a viable option for them.

How to handle leftover 529 assets

Usually, withdrawals from a 529 plan that aren't used for educational expenses face a 10% penalty. But the SECURE 2.0 Act allows up to $35,000 in 529 assets to be converted or deposited into a Roth IRA owned by the 529 beneficiary without facing this tax penalty, starting in 2024. Bear in mind there are some stipulations. For instance, the 529 plan must be held for the designated beneficiary for at least 15 years and annual conversions can't exceed the annual Roth IRA contribution limit. And the amount of 529 account funds converted to a Roth IRA may not exceed the aggregate amount contributed to the 529 plan account (including earnings on those contributions) within five years of the Roth IRA conversion distribution date.

Aside from a Roth IRA conversion, you can also change the beneficiary of the account to another child, grandchild, or another relative to fund an education. However, if the child is in a younger generation (for instance, the account was moved from the owner's child to the owner's grandchild), the funds will be considered a gift for tax purposes.

Work with your financial professionals

While any of these techniques can be useful, they're only useful insofar as they fit with your broader wealth plan. Be sure to work closely with your financial professionals to determine whether they are right for you and your family.

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* An accelerated transfer to a 529 plan (for a given beneficiary) of $90,000 (or $180,000 combined for spouses who gift split) will not result in federal transfer tax or use of any portion of the applicable federal transfer tax exemption and/or credit amounts if no further annual exclusion gifts and/or generation-skipping transfers to the same beneficiary are made over the five-year period and if the transfer is reported as a series of five equal annual transfers on Form 709, *United States Gift (and Generation-Skipping Transfer) Tax Return*. If the donor dies within the five-year period, a portion of the transferred amount will be included in the donor's estate for estate tax purposes. Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and are subject to change, which can materially affect investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

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