What Is The Best 529 Plan In California?
Hi everyone. My name is Tan, and I am an independent CERTIFIED FINANCIAL PLANNER™ practitioner. Recently a friend asked me, “what is the best 529 plan in California?” That is a great question, and I answer it frequently. Let me start from the history of 529 plans to implementing strategies if the tax law changes in the future.
Quick history of 529 plans
- Congress created 529 plans “in 1996 and they are named after section 529 of the Internal Revenue code. 'Qualified tuition program’ is the legal name (1).”
What is a 529 plan and their advantages?
- There are two types of 529 plans, prepaid tuition plans and savings plans.
- 529 savings plans are the most popular because of their flexibility. Which means you can use the money in the 529 saving plans for any qualified school instead of the prepaid tuition plans where you have to use the money for that school.
- You can use the money for “college and other post-secondary training, or for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school for a designated beneficiary, such as a child or grandchild (1).”
- Buying and selling investments inside the plan does not trigger a taxable event.
- Earnings are not taxed if used for qualified expenses.
- Qualified expenses are tuition, enrollment fees, books, supplies, equipment, room and board, computer, printer, “computer software used for educational purposes (1).”
- “To be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time (2).”
- Almost anyone can open the plan and name a beneficiary.
- There are no income restrictions to open the plan, contribute to the plan, or be the beneficiary of the plan.
- You can open as many plans as you like.
- “There are no tax consequences if you change the designated beneficiary to another member of the family (1).”
- “Any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family. So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty (1).”
- This gives you control of the plan and flexibility to change the beneficiary. If a child doesn’t need the money for education, change the beneficiary to another family member. You get to decide how much to withdraw from the plan and who gets benefit from it.
Estate planning with 529 plans
- The contribution limit for 529 plans are normally the same as the federal annual gift tax exclusion limit.
- The contribution limit for 2019 is $15,000. Which means you can contribute $15,000 into the plan if you want to. If there are husband and wife, each can contribute $15,000 into the plan, totaling $30,000 for 2019.
- You can also do a “5-year election” which means you can contribute $15,000 X 5 = $75,000 into the plan for 2019. Which means you can write a check for $75,000 and deposit into a plan today. Remember you can only do it every 5 years and you have to report on Form 709 when you file your taxes for 2019.
- Husband can contribute $75,000 and wife can contribute $75,000 into the plan for a total of $150,000 for 2019 if they want to use the 5-year election per child or grandchild without triggering federal gift taxes. If you have 4 children, that is $150,000 X 4 = $600,000 into four 529 plans every 5 years. The $600,000 is considered a complete gift and it’s out of your estate. There is no joint gift-tax return, so each person has to file separately.
- Why do investors do this? They want to move money out of their gross estate and to maximize growth in the plan. Having $75,000 in the plan and invest it today vs contributing $15,000 and investing it over 5 years can make a big difference.
What is the best plan in California?
- Currently, there are no state income tax benefits for 529 plans in California so you can pick almost any plans. Which means there are no tax deduction or credit.
- Some plans you can look into are ScholarShare, Vanguard, Fidelity, BlackRock, American Funds, and many others.
- The best 529 plans in California for you depends on your goals. Funds companies are making their plans better by decreasing fees. That’s why you want to compare and talk to a professional before making a financial decision.
Here are some questions to help you decide which plan is the best plan for you and your family
- What is the total expenses and fees on the account and investments?
- Is there a minimum account balance to get started?
- Flexibility contribution in the future?
- How easy is it to contribute and withdraw from the plan?
- Are you buying the investment at net asset value?
- Any sales fee to invest?
- Any fees for rollover the plan to another plan in the future?
Investors are doing it wrong
What I am concerned about is the parents are not maximizing their retirement accounts before starting a 529 plan for their kids.
The rationale behind this concept are:
- You can borrow for college, but you cannot borrow for retirement.
- Financial Aid weighs heavier on 529 plans than parents retirement accounts.
- What happens if the kid gets scholarships and don’t need the money in the 529 plan? Yes, you can change the beneficiary, but what if there is no beneficiary to change it to.
Red flags I have seen
- 529 plans with high management fees.
- High minimum to get started.
- The parents left the money in cash and did not invest it. You might as well open a savings account and leave it there because the point of a 529 plan is to withdraw the gain without being taxed and no taxes on buying and selling inside the plan.
- Parents have outstanding debts like credit card balances and student loans. That is a big no no for me because you are paying a high interest that is guaranteed vs playing the market in a 529 plan. What I mean by this is the investments in a 529 plan can be position or negative depending on what you invest in. With Debts, you have to pay that interest no matter what.
I am only saying this because I care and always want to put investors in the best financial position.
Strategies to take advantage of future tax law changes
Let’s say you have a BlackRock CollegeAdvantage 529, which is an Ohio plan. Your kid will go to UC Berkeley 10 years from now. The state of California does have the right to tax a qualified expense if used outside state plans. They are not doing it now, but they do have the right to do it in the future. The solution is to roll out the Ohio plan to a California plan, such as California's ScholarShare 529, and use it in California. That way, you don’t get taxed on qualified expenses.
Another scenario is, you have a BlackRock CollegeAdvantage 529, which is a Ohio plan. If the state of California offer tax deduction and credit in the future, you can roll out the Ohio plan to a California plan. If you started with a California plan, you don’t have to open another plan in the future if California offer tax deduction and credit in the future.
For premium content, please reach out to me directly. I will tell you what is my best 529 plan and why. I have done a lot of research so you don’t have to.
To your family’s success. This is Tan, your trusted advisor.
References:
(1) https://www.irs.gov/newsroom/529-plans-questions-and-answers
(2) https://www.irs.gov/pub/irs-pdf/p970.pdf
(3) https://www.scholarshare529.com/help/faq
(4) https://www.blackrock.com/us/individual/literature/brochure/oef-collegeadvantage-529-brochure.pdf
(5) https://www.savingforcollege.com/article/10-rules-for-superfunding-a-529-plan
(6) https://www.irs.gov/businesses/small-businesses-self-employed/whats-new-estate-and-gift-tax
(7) https://www.jdsupra.com/legalnews/gift-and-estate-tax-changes-5414221
(8) https://www.irs.gov/taxtopics/tc313
Additional Resources:
● Admissions rates transfer by major
https://www.universityofcalifornia.edu/about-us/information-center/transfers-major
● UC admissions rates for every high school in California
https://www.sfchronicle.com/projects/2023/uc-admissions-acceptance-rates
Additional Information
When is the deadline for 529 Plan contributions?
● “In most states, you should contribute to your 529 college savings plan by the end of the year—i.e., December 31—to maximize any state tax breaks associated with those contributions. But in other states, you can contribute until that state’s tax filing deadline next year. (The specific deadlines vary by state). For example, some of the states that don’t have a year-end contribution deadline for maximizing 529 plan contribution benefits are Iowa, Georgia, Mississippi, Oklahoma, South Carolina, and Wisconsin.”
https://www.kiplinger.com/taxes/529-plan-contribution-deadline-coming-soon-in-many-states
● On December 12, 2022, at 4:02 PM, I called ScholarShare529 at 1 (800) 544 5248. The representative stated that if you are living in California and contributing to the ScholarShare529 plan, the contribution deadline is the end of the year which is December 31st.
● You should contribute by the beginning of December to be on the safe side. If you contributed at the last minute and the contribution is not in good order (NIGO), you missed a year of contribution.
What is the maximum contribution to a 529 plan in 2022?
● 529 College Savings Plans do not have annual contribution limits, but the plans might have an overall maximum account balance limit.
● For example, with the ScholarShare 529 College Savings Account, “there is no annual limit on the amount you may contribute. However, there is an overall maximum account balance limit of $529,000, which applies to all accounts opened for a beneficiary. Accounts that have reached the maximum account balance limit may continue to accrue earnings (3).”
● With the BlackRock CollegeAdvantage 529 plan, $517,000 is the “maximum contribution amount per beneficiary (4).”
● The contribution limit for 2022 is $16,000 per beneficiary coming from an individual. This means we can contribute $16,000 to the plan per beneficiary. If there are husband and wife, each can contribute $16,000 into the plan for the same beneficiary, totaling $32,000 for 2022.
● The annual contribution to a 529 plan is considered a completed gift and is removed from our estate.
● We can also do a “5-year election” which means we can contribute $16,000 X 5 = $80,000 into the plan for 2022. We can write a check for $80,000 and deposit it into a plan today per beneficiary. Remember, we can only do it every 5 years and we have to report on Form 709 when we file our 2022 tax return.
● For example, the husband can contribute $80,000 and the wife can contribute $80,000 into the plan for a total of $160,000 for 2022 per beneficiary if they want to use the 5-year election without incurring federal gift tax.
● “An individual must live until January 1 of the fifth calendar year to “earn” the full 5-year annual exclusion. If they die during Year four, 20% of the election amount (representing the Year five portion) must be included in her gross estate. However, any earnings in the 529 plan account remain outside of their taxable estate (5).”
● If we want to give more than the 5-year election, we can report the excess amount against our lifetime estate and gift tax exemption. The estate tax exemption is $12,060,000 for 2022 (6).
● What will the estate tax exemption be in 2026? “This reset will restore the estate and gift tax exemption amount to $5 million, as it was in 2016 (though it will be indexed for inflation, resulting in an exemption amount of roughly $6.6 million in 2026). Again, this is the law as it stands today; without further action, it will remain the law (7).”
529 Plan Withdrawal Rules:
● “You should receive a Form 1099-Q, Payments from Qualified Education Programs (Under Sections 529 and 530) from each of the programs from which you received a QTP distribution. The amount of your gross distribution (box 1) shown on each form will be divided between your earnings (box 2) and your basis or return of investment (box 3).”
https://www.irs.gov/taxtopics/tc313
● Form 1099-Q, Payments from Qualified Education Programs (Under Sections 529 and 530)
https://www.irs.gov/forms-pubs/about-form-1099-q
● “If withdrawing for a non-qualified expense, do FIFO or FILO rules apply? No. The earnings portion of a distribution is assumed to be proportional to the total earnings in the 529 plan.”
https://www.savingforcollege.com/article/answers-to-questions-about-distributions-from-a-529-plan
● “Withdrawals come out of the account on a pro rata basis, meaning the withdrawal consists of two parts – return of principal and earnings. The principal portion of the withdrawal is federal tax-free, while the earnings portion may be taxable if not used for a qualified expense. The form 1099-Q will show how much of the withdrawal consists of return of principal and how much consists of earnings.”
https://www.raymondjames.com/-/media/rj/advisor-sites/sites/t/n/tnrp/files/pdf/withdrawing-from-529-plan.pdf
● “The earnings portion of a withdrawal for non-qualified expenses is taxed as ordinary income and assessed an additional 10% penalty tax.”
https://www.raymondjames.com/-/media/rj/advisor-sites/sites/t/n/tnrp/files/pdf/withdrawing-from-529-plan.pdf
● “The earnings portion of a non-qualified distribution from a 529 plan is normally subject to income tax and a 10% tax penalty, plus possible recapture of state income tax breaks attributable to the distribution.”
https://www.savingforcollege.com/article/answers-to-questions-about-distributions-from-a-529-plan
● “In most cases, it may be best to request withdrawals in the beneficiary’s name or to the school as any refunds that may become taxable will be at the student’s income tax rate.”
https://www.raymondjames.com/-/media/rj/advisor-sites/sites/t/n/tnrp/files/pdf/withdrawing-from-529-plan.pdf
● “Being able to direct distributions to the beneficiary provides an added opportunity for tax mitigation on non-qualified distributions.”
https://www.columbiathreadneedleus.com/binaries/content/assets/cti-blog/final_h48m_fs_advisorbacktoschool_whitepaper.pdf
● “You could have the money distributed from the 529 account to your child. If some of the money is used for nonqualified expenses, such as buying a car, there may be reportable earnings—which will go on your child's tax return. Any earnings are taxed at your child's lower tax bracket—unless the so-called "kiddie tax" applies. The kiddie tax requires certain children as old as 23 to pay tax on unearned income at their parents' marginal tax rate. Check with your tax professional to see if this applies...Ask your plan provider for instructions if you are interested in distributing money directly to the beneficiary.”
https://www.fidelity.com/learning-center/personal-finance/college-planning/college-529-spending
“Options for Unused 529 Plan Funds
What happen to the money in a 529 college savings plan, if later it will not be used?
Money can stay in a 529 plan forever.
There are several options for using the leftover money in a 529 plan.
● Change the beneficiary to a sibling or the parent, to use for their education
● Take a distribution to pay for up to $10,000 in student loans per borrower for the beneficiary, the beneficiary’s siblings or, with a change in beneficiary, the parent or another family member
● Use the 529 plan to pay for graduate school or continuing education
● Save the money for the beneficiary’s children
● Take a non-qualified distribution”
https://www.savingforcollege.com/article/answers-to-questions-about-distributions-from-a-529-plan
“In SECURE 2.0, signed into law on December 29, 2022, Congress attempted to address this problem. Starting in 2024, beneficiaries of 529 college savings accounts (e.g., children or grandchildren) will be allowed to do a tax-free rollover of up to $35,000 to a Roth IRA.
As usual, however, the “devil is in the details.” Here are those details:
● The $35,000 limit is a lifetime maximum.
● The Roth IRA must be in the name of the 529 beneficiary – not the 529 owner (if different).
● The 529 plan must have been open for more than 15 years. It’s not clear whether a new 15-year waiting period is required when someone changes 529 beneficiaries or if the waiting period that applied to the prior beneficiary can be tacked on. We’ll need further clarification from Congress or the IRS.
● Rollover amounts can’t include any 529 contributions (and earnings on those contributions) made in the preceding five-year period.
● Rollovers are subject to the annual Roth IRA contribution limit. So, for example, if the Roth IRA contribution limit in 2024 remains $6,500, then no more than $6,500 can be rolled over from a 529 to a Roth IRA in 2024. Further, any actual Roth IRA (or traditional IRA) contributions made by the 529 beneficiary would count against the $6,500 limit. The effect of this rule is that a full $35,000 529-to-Roth IRA rollover would need to be done over several years. It also means that the 529 beneficiary doing the rollover must have compensation in that year at least equal to the amount being rolled over.
● By contrast, the income limitations on Roth IRA contributions don’t apply to these rollovers. A 529 beneficiary would be able to do a 529-to-Roth IRA rollover even if she earns too much to make a Roth IRA contribution for that year.”
https://www.irahelp.com/slottreport/secure-20-allows-rollovers-529-funds-roth-iras
“529 Plans. After 15 years, 529 plan assets can be rolled over to a Roth IRA for the beneficiary, subject to annual Roth contribution limits and an aggregate lifetime limit of $35,000. Rollovers cannot exceed the aggregate before the 5-year period ending on the date of the distribution. The rollover is treated as a contribution towards the annual Roth IRA contribution limit.”
https://www.fidelity.com/learning-center/personal-finance/secure-act-2
For purposes of qualified tuition programs (QTPs), “qualified higher education expenses include tuition expenses in connection with a designated beneficiary's enrollment or attendance at an elementary or secondary public, private, or religious school, i.e., kindergarten through grade 12, up to a total amount of $10,000 per year from all of the designated beneficiary's QTPs. They also include expenses for fees, books, supplies, and equipment required for the participation in an apprenticeship program registered and certified with the Secretary of Labor and qualified education loan repayments in limited amounts.” This is at the federal level. Possibly at the state level depending on the state you live in.
https://www.irs.gov/taxtopics/tc313
Based on the Saving For College website, "many states do not consider K-12 education to be a qualifying expense which means they have not decided to follow the federal tax laws on the matter. If you live in one of these states and take money out of your 529 plan in order to pay for K-12 education then you may end up owing state taxes for the withdrawal.
The states where you may owe for these withdrawals are:
California
Colorado
Hawaii
Illinois
Michigan
Minnesota
Montana
Nebraska
New Mexico
New York
Oregon
Vermont
Keep in mind that this law is still somewhat new and so changes could happen at the state level at any time."
https://www.savingforcollege.com/article/529-savings-plans-and-private-school-tuition
“Withdrawals for tuition expenses at a public, private or religious elementary, middle, or high school can be withdrawn free from federal tax. For California taxpayers these withdrawals are subject to state income tax and an additional 2.5% California tax. Withdrawals for registered apprenticeship programs and student loans can be withdrawn free from federal and California income tax.”
https://www.scholarshare529.com/learn/how-does-a-529-plan-work#footnotes_1
“For 2022, the annual exclusion is $16,000.”
https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes
“The annual exclusion for gifts increases to $17,000 for calendar year 2023, up from $16,000 for calendar year 2022.”
https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023
This material is for educational use only and does not constitute tax, legal, or investment advice. Information may be changed or updated without notice. Consult with a licensed professional regarding your personal circumstances.
Please do not excerpt or copy this information without prior consent from TAN Wealth Management.