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Five hidden benefits of 529 college savings plans

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A Section 529 college savings plan can be a great tax-advantaged way to save for an education—your children's, your own or anyone else's—and it may offer surprising financial flexibility.

If you establish a 529 plan to pay for college or for graduate or vocational school, you may be able to take advantage of federal and possibly state income tax benefits. Earnings in a 529 account can grow tax-free, and withdrawals, including any earnings are federal and possibly state income tax free, as long as the money is used for qualified higher education expenses.1

"Every dollar you put aside now is one dollar less you have to find, or borrow, later."

– Richard J. Polimeni, director, education
savings programs, Merrill Lynch

Opening and contributing to a 529 plan could be crucial in helping a student afford college. "Every dollar you put aside now is one dollar less you have to find, or borrow, later," says Richard J. Polimeni, director, education savings programs, Bank of America Merrill Lynch.

Here are five hidden ways to benefit from 529 plans:

1) A 529 account can provide you with favorable treatment when applying for financial aid

"Often, people mistakenly believe that because a 529 plan account is earmarked for higher education, it will have a negative impact on financial aid eligibility," says Polimeni. "In fact, investing for college with a 529 plan is treated more favorably in the federal financial aid formula than saving in your child's name through a custodial account, such as a UTMA/UGMA." In general, financial need is defined as the difference between the total cost of college and the expected family contribution. Assets in a 529 plan for a minor child are owned by a parent, and according to federal financial aid formulas, parents' funds are tapped at a lower rate than those held in a child's name when it comes to calculating the expected family contribution. According to the College Savings Plans Network, during each year that a child is in college, parents are expected to contribute about 5.6% of the assets saved in a 529 college savings plan account. In contrast, 20% of the money saved in a custodial account, such as an UTMA/UGMA, which belongs to the child, must be counted toward the family's contribution to college each year.2

2) If the student gets a scholarship, you can repurpose some or all of the 529 plan funds

Your straight-A student or basketball star may give you an unexpected cash gift by earning a college scholarship. You can withdraw an amount equal to the scholarship from the 529 plan without incurring the 10% additional federal tax that is normally required on withdrawals that are not used to pay for higher-education costs. You would only have to pay ordinary income tax on any earnings on the amount returned to you. That money can be used to help you meet other financial goals, such as saving for retirement.

Another option is to give those unneeded 529 plan assets to another relative to use for college. You can change the account's beneficiary to a member of the family of the person for whom the account was originally intended—for example, one of your other children or even a first cousin.3

3) You can use a 529 plan to fund your own education

Funds in a 529 plan can be used at an accredited post-secondary institution—including technical or vocational schools—to help pay for higher education. And, anyone age 18 or older with a social security number and residing in the U.S. can open and fund an account. You can open an account for yourself, or open or contribute to one for someone else, including nonrelatives. It's a great way to pursue training for your current career or a new career for which you previously did not have the resources.

4) Contributing to a 529 plan could bring you a significant tax advantage

Nearly every state sponsors its own 529 plan, which can be used to pay costs at accredited schools in any state, and many offer a deduction on state income tax to residents who contribute to their home state's plan. "It's important to consider any benefits available in your home state, but you need to evaluate a particular 529 plan like you would any other investment," says Polimeni. "You'll want to look at the plan's investment manager, investment options, plan performance and underlying fees and expenses before you invest."

In 2017, you can contribute $14,000 ($28,000 per married couple) to a 529 plan for each beneficiary without triggering federal gift taxes or using your lifetime estate- and gift-tax exemption of $5.34 million per individual taxpayer. While contributions to 529 plans are not deductible on your federal tax return, the investments have the opportunity to grow tax-deferred, and distributions to pay for a beneficiary's college costs are federally tax-free, as long as withdrawals are used for qualified higher-education expenses.1

5) You can transfer the wealth with a 529 plan

Contributing to a 529 plan also can help grandparents or others reduce the size of their taxable estates. They can even accelerate their gifting timetable by combining five years of 529 plan contributions of as much as $140,000 per couple (up to $70,000 for individuals) in one year, per beneficiary, using the annual gift exemption. Keep in mind that within the five-year period you would not be able to make any more taxable gifts to the beneficiary.4

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Before you invest in a Section 529 plan, request the plan's official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses and risks of investing in the plan, which you should carefully consider before investing. You should also consider whether your home state or your designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds and protection against creditors that are available only for investments in such state's 529 plan. Section 529 plans are not guaranteed by any state or federal agency.

1 To be eligible for favorable tax treatment afforded to any earnings portion of withdrawals from Section 529 accounts, such withdrawals must be used for "qualified higher education expenses," as defined in the Internal Revenue Code. Any earnings withdrawn that are not used for such expenses are subject to federal income tax and may be subject to a 10% additional federal tax, as well as applicable state and local income taxes.

2 Financial aid rules may change, and the rules in effect at the time the beneficiary applies may be different. For more complete information, visit the U.S. Department of Education website at www.ed.gov. The College Savings Plans Network is an affiliate to the National Association of State Treasurers and serves as a clearinghouse for information among state-administered college savings programs. http://www.collegesavings.org/commonQuestions.aspx#schoolAdmissionFinancialAid

3 The account owner can change the beneficiary to another member of the family of the original beneficiary without penalty. Please refer to the Internal Revenue Code definition of "member of the family." If assets are contributed from an UTMA/UGMA account, the custodian may not change the designated minor, except as permitted by applicable law.

4 For 2017, individuals can gift up to $70,000 ($140,000 for married couples filing jointly) per beneficiary in a single year without incurring gift tax. Contributions between $14,000 and $70,000 ($28,000 and $140,000 for married couples filing jointly) made in one year can be prorated over a five-year period without subjecting you to gift tax or reducing your federal unified estate and gift tax credit. If you contribute less than the $70,000 ($140,000 for married couples filing jointly) maximum, additional contributions can be made without you being subject to federal gift tax, up to a prorated level of $14,000 ($28,000 for married couples filing jointly) per year. Gift taxation may result if a contribution exceeds the available annual gift tax exclusion amount remaining for a given beneficiary in the year of contribution. For contributions between $14,000 and $70,000 ($28,000 and $140,000 for married couples filing jointly) made in one year, if the account owner dies before the end of the five-year period, a prorated portion of the contribution may be included in his or her estate for estate tax purposes.

Please remember there's always the potential of losing money when you invest in securities.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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