529 Plans are a popular way to save for the ever-increasing cost of college. Though a 529 education savings plan is a creation of federal law, each state implements its own rules regarding where and how the funds may be invested, and various perks that may accompany contributions. A 2023 change in Maine law offers an incentive for funding 529 plans to pay for college in the years ahead.
Beginning in 2023, Maine taxpayers can claim an income tax deduction of up to $1000 per student for contributions made to the student’s 529 plan. To qualify for the deduction, contributors must earn less than $100,000 if filing single, or $200,000 if filing jointly. The deduction is permitted per designated beneficiary, or recipient of the funds. A grandparent contributing $1,000 to each of her five grandchildren’s 529 plans could be eligible for a $5,000 deduction.
Contributions to a 529 plan grow tax-deferred, and qualified distributions are tax-free. Qualified educational expenses include not only tuition at an eligible college, vocational or trade school, but also up to $10,000 of K-12 tuition at public or private school, room and board, books, computers, and certain supplies.
Overfunding a 529 plan is not necessarily the worry it once was under the federal SECURE Act 2.0, which allows up to $35,000 of funds remaining in a 529 plan to be rolled over to a Roth IRA if certain conditions are met. Additionally, beneficiaries of the 529 account (i.e., the student) can be changed by the owner of the account (parent or grandparent) to utilize remaining funds for younger family members.
Any college saving is good savings, but savvy college savers are cautious about how the value of a 529 account can affect a student’s eligibility for need-based financial aid, depending on who owns the account and when funds are disbursed. Determination of need-based aid is calculated by the schools with reliance on the Free Application for Federal Student Aid (FAFSA), and/or the College Scholarship Service Profile (CSS) which is used by about 300 colleges to provide non-federal aid. Through these applications, parent and student income and assets are run through a calculation to determine how much need-based aid an institution decides the student is eligible for.
Roughly and generally, about 5% of parental assets will be considered “available” assets, and up to about 40% of total parental income will be included. 20% of student assets and about 50% of student adjusted available income will be included. Financial aid applications report income from two years prior (so, 2022 income will be reported on a 2024-2025 FAFSA application) and asset values as of the day of filing the application (indeed, parents are often encouraged to keep screen shots of their accounts on the date of filing). Prolific savers may be surprised to find that all that hard work in saving money for college might actually hurt a student’s eligibility for need-based aid, where the 529 account owned by a parent will be considered an asset and the distribution from that account to pay for college expenses will be considered available income to the student (not taxable income) reported on the financial aid applications. For this reason, it can be helpful for the grandparent to own the account as opposed to the parent. Some grandparents postpone distributions until the student’s junior year of college, where those distributions will not affect further financial aid eligibility.New federal law will change the way certain assets and income are considered on the FAFSA beginning with the 2024-2025 applications and may eliminate this “penalty” of treating grandparent 529 distributions as income.
Financial planning for college is tricky, but always worthwhile. With the new benefit of a Maine income tax deduction, and new options for excess funds, it certainly can’t hurt to plan, as the cost of college seems to grow as fast as the kids do.