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In this article we are going to take a deep dive into the rules and regulations of 529 plans.
Securities exam takers should master this material to ensure success.
If you are preparing for the SIE Exam, Series 7, Series 10, or Series 65 Exam, you can expect to encounter questions covering 529 plans.
Types of 529 Plans
There are two types of 529 plans:
- Prepaid Tuition Plans
- 529 Savings Plans
Prepaid Tuition Plans
Prepaid tuition plans allow tuition credits to be purchased at today’s prices and used when the beneficiary is ready to attend school in the state.
The credits are valid at various educational institutions in the state sponsoring the program, and if the beneficiary decides to attend school in another state, some of the credits may transfer.
529 Savings Plans
A 529 savings plan is an account offering investment options including mutual funds and ETFs. Usually it is a family member putting money away for a child’s education, but the beneficiary does not have to be a child—or even a relative of the donor.
In fact, individuals can set up a 529 savings plan for themselves, in case they plan to earn a graduate degree in 10 years, for example.
The person who opens the account is the custodian, and the beneficiary is the person who will use the money for education. For 529 savings plans, the owner/custodian controls the assets.
Tax Treatment of 529 Plans
For purposes of federal income taxes, contributions are non-deductible, but withdrawals used for qualified education expenses are tax-free.
To receive tax-free treatment on the back end for both federal and state income taxes, the withdrawals must be qualified withdrawals that cover tuition, room & board, books, etc.
Qualified education expenses also include computer technology, which as the IRS explains:
“Includes the cost of the purchase of any computer technology, related equipment and/or related services such as Internet access. The technology, equipment or services qualify if they are used by the beneficiary of the plan and the beneficiary’s family during any of the years the beneficiary is enrolled at an eligible educational institution.”
There are no income limits for the owner of the account.
Changing Beneficiaries and Tax Implications
If the beneficiary ends up not needing the money, the account can name a second beneficiary without tax problems, provided the second beneficiary is related to the first.
However, this is an area that can easily lead to confusion. When setting up a 529 plan, it makes no difference whether the account owner is related to the beneficiary.
But if the beneficiary is unwilling to attend college or technical school, the account owner can:
- Change the beneficiary to a blood relative of the original beneficiary to avoid tax implications, or
- Become the beneficiary themselves.
Naming a beneficiary other than the account owner or a blood relative leads to taxation on any gains in the account.
Gift Tax Rules and Contribution Limits
When the donor contributes to a 529 savings plan on behalf of the beneficiary, the tax code considers this a gift. Gifts over a certain amount are taxable to the one making the gift.
With a 529 savings plan, the donor can contribute up to the gift tax exclusion without incurring gift taxes, and can even do a lump-sum contribution for the first five years without incurring gift tax hassles.
For example, if the annual gift tax exclusion is $19,000, the donor can contribute $95,000 for the next five years. A married couple can contribute a combined $190,000 under the superfund option.
However, if the five-year-up-front method is used, no additional gifts to that beneficiary can be made for the next five years without triggering gift taxes.
Each state sets the maximum amount that may be contributed on behalf of a beneficiary, defined by the IRS as:
“The amount necessary to provide for the qualified education expenses of the beneficiary.”
Unlike mutual fund investments, the account owner may only change the asset allocation among the investment options twice per year.
Usage and Flexibility
529 Savings Plans are used primarily for higher education, but recent tax code changes now allow funds to be used for private K-12 tuition expenses (subject to annual limits).
Such early withdrawals are exceptions rather than the rule for how account owners typically use college savings plans.
The owner of the 529 plan maintains control over the assets and decides when withdrawals will be made.
Direct-Sold vs. Advisor-Sold Plans
Some plans are available directly from the state that sponsors them (called direct-sold plans). Others are available through broker-dealers and financial advisors (called advisor-sold plans).
Generally, while advisor-sold plans may offer broader investment menus, their fees are higher, and after factoring in those fees, most direct-sold plans outperform their advisor-sold counterparts.
ABLE Accounts (529A Accounts)
Section 529A of the Internal Revenue Code covers ABLE Accounts — tax-advantaged savings programs for eligible individuals with disabilities.
The Achieving a Better Life Experience (ABLE) Act of 2014 allows states to create these programs. Funds from ABLE accounts can help designated beneficiaries pay for qualified disability expenses.
Key Features of ABLE Accounts
- Tax-Free Distributions: As with a 529 savings plan, distributions are tax-free if used for qualified disability expenses.
- Qualified expenses include education, transportation, housing, and healthcare — any expenses that maintain or improve the beneficiary’s quality of life.
- Anyone can open an ABLE account if they are an eligible individual with a significant disability that occurred before their 26th birthday.
- Generally, only the designated beneficiary can open the account. However, a guardian or person with power of attorney may manage it on their behalf if necessary.
- Once the account is opened, the owner selects investment options, and may change asset allocation only twice per year.
- Only one ABLE account is permitted per eligible individual.
Balances below $100,000 do not affect SSI benefits, and Medicaid benefits are not impacted by account balances.
Contributions and Limits
- Up to $19,000 per calendar year (the annual federal gift tax exclusion) may be contributed by all parties combined.
- Contributions are treated as gifts and subject to normal gift tax rules.
- In addition, a working beneficiary may contribute earned income up to the poverty line amount for a one-person household.
- Each state limits the maximum contribution amount, generally tied to that state’s 529 plan limit (often around $350,000).
Additional Notes
- States may offer resident benefits for investing in their own ABLE programs, such as lower fees or state tax benefits.
- Instead of a prospectus, ABLE programs use a Program Disclosure Booklet, which outlines fees, risks, and investment options.
- The tax code allows limited rollovers from a 529 qualified tuition program to an ABLE account for the same beneficiary or a qualifying family member.
Final Thoughts
Understanding the rules, tax treatment, and mechanics of 529 and ABLE accounts is crucial for success on licensing exams like the SIE, Series 7, Series 10, and Series 65.
For exam takers and financial professionals alike, mastering this material ensures you can confidently address questions on education savings, tax advantages, and account structure — all key areas for both clients and your own professional success. We hope this article has helped you master these key concepts.
Good Luck On Your Exam !
The Securities Institute of America
