529 Plans – The Maryland Prepaid College Trust

529 Plan

The 529 plan is a tax-advantaged account most commonly used to fund college expenses.  The federal government sanctions the accounts, but they are offered by individual states.  Maryland offers two plan options: The Maryland Prepaid College Trust (MPCT) and The Maryland College Investment Plan (MCIP).

The former allows individuals to prepay for tuition expenses at today’s rates.  The latter allows individuals to establish, contribute, and invest money for education expenses.

Some states offer prepaid tuition options, but all 50 states offer the investment plans.  Tax benefits are generally reserved for state residents who contribute to their own state’s plan.  Funds from both investment and prepaid tuition plans can be used to pay for education expenses in any state.

The Maryland Prepaid College Trust

Maryland’s Prepaid College Trust (MPCT) is a 529 plan that operates like a pension system.  Money is contributed by individuals in exchange for a predetermined future benefit.  A trustee is charged with investing and managing the money that is contributed.

With the MPCT, the benefit individuals purchase are future college tuition credits.  The cost of the benefit is determined by a number of factors, including the age of the beneficiary, projected college enrollment date, cost of tuition, and the trust’s expected investment returns and expenses.

By prepaying tuition ahead of time, individuals effectively lock-in the prices they will pay for future tuition now.  This effectively transfers the investment risk from the individual to the MPCT.  It also makes the trustee responsible for managing the growth of the assets to ensure that benefits are paid out as promised.

If the trust has insufficient resources to pay benefits in a given year, the state has promised to make up the difference under the Maryland Legislative Guarantee, subject to approval by the Maryland General Assembly.  The trust has discretion over what is done when returns exceed expectations.  In the past, excess returns have been credited to account holders but the amount of credits account holders earned from those excess returns has been a point of debate.

Prepaid credits purchased through the MPCT are redeemable to pay full tuition expenses at any public college in the State of Maryland, regardless of how much tuition costs may rise when benefits are actually paid.  The credits can also be redeemed to pay tuition expenses at any private or out-of-state college/university as well.  However, the value of the credits is determined based on the weighted average cost of tuition at Maryland colleges and universities.  This means that using the credits for private or out-of-state college/university could result in only partial payments being made for the credits received.

Owner, Beneficiary, & The Impact on Financial Aid

Accounts are established by owners for a beneficiary.  This is true whether the 529 is an investment or prepaid tuition plan.  When the person that sets up the account is a parent or student, the asset has little impact on financial aid — an approximate 5.64% reduction can be expected on the aid that a student would otherwise receive if they or their parents are owner of a 529 account.

When establishing an account under a prepaid tuition plan, either the owner or beneficiary is required to be a resident of the state offering the plan.  However, the owner of a 529 account reserves the right to change the beneficiary of the account without triggering a tax consequence in most circumstances.

The account owner can change the beneficiary to nearly any relative of the beneficiary.  However, since prepaid tuition plans factor the age of the beneficiary and their projected college enrollment date into the prepaid tuition cost calculation, changing beneficiaries may reduce benefits or require that larger payments be made to sustain the benefits that were originally selected.

Moreover, there is a general limitation to naming someone beneficiary who is more than one generation removed from the current beneficiary.  If such a change is made, say from a grandparent to a grandchild, a generation skipping tax would likely apply to the money that has been contributed.

Changing ownership of the account is possible, too.  Most state plans, including the Maryland 529, allow for the owner of the account to be changed as often as once per year, but some states only allow ownership changes under certain circumstances, like death or divorce.  If a 529 account is funded from proceeds of a UTMA or UGMA account, the owner must be the same as the owner of the UTMA or UGMA account where the funds originated.

Contribution Rules, Plan Options, & Payment Methods

Contributions made to the MPCT are used to purchase tuition credits.  The Maryland 529 Plan allows for contributions of up to $500,000 for a single beneficiary, regardless of how many accounts name them as beneficiary.  Once the total balance of all accounts for a single beneficiary reaches this threshold, contributions are no longer permitted.  This includes amounts held in the Maryland College Investment Plan.

The MPCT offers three plan options with varying benefits.  Those plan options are:

• University Plan
• Community College Plan
• Two Plus Two Plan

The University Plan allows individuals to purchase a minimum of one (1) semester of tuition or a maximum of four (4) years’ worth of tuition at the university level.  The Community College Plan allows individuals to purchase either one (1) or two (2) years’ worth of tuition at the community college level.  The Two Plus Two Plan allows individuals to purchase a minimum of two (2) years’ worth of tuition at the community college level plus two (2) years’ worth of tuition at the university level.

Contributions to the plan can be used to purchase tuition credits using one of five methods:

• Lump Sum
• Annual installment
• Five (5) year monthly payments
• Equal monthly payments up to the December before high school graduation
• Periodic payments

The younger the beneficiary and the more quickly payments are made, the lower the overall cost is to purchase tuition credits.  Failure to make the scheduled payments will result in either lower credit amounts being earned, higher future costs to purchase the same amount of credits, or termination from the plan.

The deadline for prepaying tuition within the MPCT is December 31st for tax purposes.  Checks have to be post marked by this date to count for the tax year.  When sending money electronically through a bank draft, the funds have to be received by the plan no later than this date, therefore, it is best to factor in 3-5 days for processing of electronic contributions.

Tax Rules, Benefits, & Penalties

Contributions to a 529 plan do not receive any upfront federal tax benefits, but residents of Maryland who contribute to a Maryland 529 plan receive a state tax deduction of up to $2,500 per year per beneficiary.  Contributions to the Maryland College Investment Plan are counted separately from prepaid tuition payments made in the Maryland Prepaid College Trust.

Each individual contributor and resident of Maryland can deduct their contribution to a Maryland 529 account every year.  This deduction applies to each account that has a unique beneficiary, so contributions to multiple accounts multiplies the deduction amount.

Federal tax rules do limit how much can be contributed to a 529 plan by an individual in a single year before triggering a tax consequence.  The federal contribution limit is 5-times the annual gift tax exclusion amount, which in 2023 is $17,000.  This means that a single person can purchase as much as $85,000 in prepaid tuition within a single account once every five years without the purchase creating gift tax liability or chipping away at their federal lifetime gift and estate tax exemption.

Like retirement accounts, earnings that accrue in a 529 plan are tax-free, meaning that taxes are not due each year on interest, dividends, or capital gains.  If distributions are used to pay for qualified tuition expenses, the full amount of the distribution is tax-free.  If distributions are made to pay for non-qualified expenses, then earnings are subject to a tax penalty of 10% as well as taxation as income.

Qualified education expenses generally include:

• Tuition expense
• Room & board (some limitations apply)
• Books
• Supplies and equipment required for a course of study
• Fees related to enrollment or attendance at an eligible educational institution

Where limitations apply, certain conditions must be met to avoid taxation and penalties.  For instance, room & board is only considered a qualified expense if the student is: enrolled in a program that is expected to lead to a recognized academic credential, is enrolled on at least a half-time basis, and incurs housing expenses that do not exceed the college’s cost of attendance allowance.

In some instances, there are distributions that can be made without triggering the 10% penalty.  This is the case when the beneficiary of the account:

• Receives a tax-free scholarship, including a veteran’s education benefit
• Receives educational assistance through a qualifying employer program
• Attends a U.S. military academy
• Becomes disabled or dies

In these instances, distributions can be made but they must generally not exceed the value of the scholarship, assistance, or aid in order to avoid the penalty.  However, the amount of the distribution that is considered earnings is still subject to income taxation.  The money can also be rolled over to a 529 investment plan.

Distribution Rules

The Maryland Prepaid College Trust requires accounts be in effect for a minimum of three (3) years before benefits are paid out.  Additionally, the MPCT limits tuition expense to 15 credit hours per semester and up to 30 credit hours per year.  To receive benefits, the account owner has to request payment be made to an eligible institution.  Additionally, the beneficiary of the account must be enrolled on at least a half-time basis.

Beneficiaries have ten (10) years to use the benefits in the account once completing high school, unless they qualify for a waiver.  Active-duty military service makes one eligible for a waiver to this time limit.  Unlike the Maryland College Investment Plan, benefits cannot be used to pay for private K-12 school tuition, nor can benefits be used to pay for non-degree granting certificate programs.

If the prepaid tuition credits are not used by the 10-year deadline, the plan will terminate and all earnings on the contributions made over the life of the account will be forfeited to the state.  Account owners will be given the option to either roll over contributions to a 529 investment plan or have them refunded.

Rollover & Transfer Rules

When applied to 529 accounts, the terms rollover and transfer carry a different meaning than how the terms apply to retirement accounts like the Roth IRA.

Rollover as it relates to 529 accounts is the process of moving money from one state’s plan to another state’s plan or moving money between an investment plan and a prepaid tuition plan.  Transfers on the other hand are synonymous with changing the beneficiary of the account and can occur within a state plan or as part of a rollover.

When performing a rollover, the transaction needs to be initiated by the receiving plan.  This means first opening a new 529 account and then requesting the rollover.  Doing so, will allow for the funds to be moved from trustee-to-trustee, which in most cases eliminates the tax consequences of the transaction.

In Maryland, rollovers to another state’s plan are permitted and are not subject to tax recapture; but this is not true for all state plans.  Additionally, if the funds being rolled into a plan originate from a UTMA or UGMA account, the beneficiary of the new account must be the same as the beneficiary of the originating account.  This cannot be changed because the money that is being contributed is considered an irrevocable gift to the beneficiary.

Only one rollover from a Maryland 529 account is permitted every 12-months per beneficiary.  Transacting more than this results in a nonqualified distribution, which triggers the 10% tax penalty and income tax on earnings.