What is a 529 plan?
A 529 plan is a tax-efficient savings plan designed to help pay for education. Initially limited to post-secondary education costs, it was expanded to cover K-12 education in 2017 and apprenticeship programs in 2019.
The two main types of 529 plans are college savings plans and prepaid tuition plans.
Education savings plans are growing tax-deferred, and withdrawals are tax-free if used for eligible educational expenses. Prepaid tuition plans allow the account holder to pay current tuition for future attendance at designated colleges and universities. This means that, most likely, you can lock in a lower college attendance cost.
529 plans are also referred to as qualified tuition programs and Section 529 plans.
Key points to remember
- 529 plans are tax-advantaged accounts that can be used to pay for education costs from kindergarten through graduate school.
- There are two basic types of 529 plans: college savings plans and prepaid tuition plans.
- 529 plans are sponsored and operated by all 50 states and the District of Columbia.
- Rules and fees for 529 plans may differ by state.
- 529 plans can be purchased directly from a state or through a broker or financial advisor.
Understand 529 plans
Although 529 plans take their name from Section 529 of the federal tax code, the plans themselves are administered by all 50 states and the District of Columbia.
Anyone can open a 529 account, but they are usually created by parents or grandparents on behalf of a child or grandchild, who is the account holder. Beneficiary.
In some states, the person funding the account may be eligible for a state tax deduction for their contributions.
Money in a 529 plan grows tax-deferred until it is withdrawn. Additionally, as long as the money is used for qualified educational expenses as defined by the IRS, those withdrawals are not subject to state or federal taxes. Additionally, some states may offer Tax deductions on contributions.
For K-12 students, tax-free withdrawals are limited to $10,000 per year.
Since tax benefits vary by state, it is important that you check the details of any 529 plan to understand the specific tax benefits you may or may not be entitled to.
Types of packages 529
The two main types of 529 plans have significant differences.
Education savings plans
529 savings plans are the most common type. The account holder contributes money to the scheme. This money is invested in a predefined selection of investment options.
Account holders can choose the investment (usually mutual funds) in which they wish to invest. The performance of these investments will determine the increase in value of the account over time.
Many 529 plans offer target date fundwho adjust their assets over time, becoming more conservative as the beneficiary approaches college age.
Withdrawals from a 529 savings plan can be used for both eligible college and K-12 expenses. Eligible expenses include tuition, fees, room and board, and related costs.
The SECURE Act of 2019 expanded tax-free 529 plan withdrawals to include registered apprenticeship program expenses and up to $10,000 in student loan debt repayment for account beneficiaries and their siblings and sisters.
Prepaid Tuition Plans
Prepaid Tuition Plans are offered by a limited number of states and some higher education institutions. They vary in their specifics, but the general principle is that they allow you to lock in tuition at current rates for a student who may not be attending college for years. Prepaid plans are not available for K-12 education.
As with 529 savings plans, prepaid tuition plans increase in value over time. Any withdrawals from the account used to pay tuition fees are not taxable. However, unlike savings plans, prepaid tuition plans do not cover room and board costs.
Prepaid tuition plans may place a restriction on which colleges they can be used for. Money from a savings plan, on the other hand, can be used at almost any eligible institution.
Additionally, the money paid into a prepaid tuition plan is not guaranteed by the federal government and may not be guaranteed by some states. Make sure you understand all aspects of the prepaid tuition plan.
There are no limits on the amount you can contribute to a 529 account each year. However, many states cap the total amount you can contribute. These limits recently ranged from $235,000 to over $525,000.
Tax Benefits of 529 Plans
Withdrawals from a 529 plan are exempt from federal and state income taxes, provided the money is used for qualified educational expenses.
All other withdrawals are subject to tax plus a 10% penalty, with exceptions for certain circumstances, such as death or disability.
The money you contribute to a 529 plan is not tax deductible for federal income tax purposes. However, more than 30 states offer deductions or tax credits of varying amounts for contributions to a 529 plan.
In general, you will need to invest in your home state’s plan if you want to qualify for a state tax deduction or credit. If you’re willing to give up tax relief, some states will allow you to invest in their plans as a nonresident.
Advantages and Disadvantages of 529 Plans
| Advantages | Disadvantages |
|---|---|
| High contribution ceiling | Limited investment options |
| Flexible plan location | Different fee levels by state |
| Easy to open and maintain | Fees may vary; restriction on changes of plans |
| Tax-deferred growth | Restriction on change of placement |
| Tax Free Withdrawals | Must be used for education |
| Tax deductible contributions | Depends on the state; restrictions apply |
529 Plan Portability Rules
529 plans have specific portability rules governed by the federal tax code (Section 529).
The owner (usually you) can transfer to another 529 plan only once a year, unless a change in beneficiary is involved. You do not have to change plans to change beneficiaries. You can transfer the plan to another family member, who is defined as:
- Son, daughter, son-in-law, adoptive child, adopted child or descendant of one of them
- Brother, sister, half-brother or half-sister
- Father or mother or ancestor of either
- Father-in-law or mother-in-law
- Son or daughter of a brother or sister
- Brother or sister of father or mother
- Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
- The spouse of any person mentioned above
- Cousin
You are not limited to investing in your own state’s 529 plan, but it may provide you with tax relief. Be sure to check out this plan first.
Special Considerations
As with other types of investing, the earlier you start, the better. With a 529 plan, your money will have more time to grow and accumulate the sooner it’s opened and funded.
With a prepaid tuition plan, you will most likely be able to lock in less tuition than you would pay later, as many schools increase their prices every year.
If you have money left in a 529 plan – for example, if the beneficiary gets a substantial scholarship or decides not to go to college at all – you will have several options.
One is to change the beneficiary of the account to another parent who qualifies under portability rules. Another is to keep the current beneficiary in case they change their mind about college or later go on to graduate school. Finally, you can always cash the account and pay the taxes and the 10% penalty.
How do I open a 529 plan?
529 plans can be opened directly with a state. Alternatively, many brokers and financial advisers offer 529 plans. They can help you choose from a selection of plans located across the country.
How much does a 529 plan cost?
States often charge one-time account setup fees for a 529 plan. These range from as little as $25 (in Florida) to $964 (in West Virginia) for the cheapest option. Additionally, if you purchased your 529 plan through a broker or advisor, they may charge you up to 5% or more on assets under management. The individual investments and funds you have inside your 529 may also charge ongoing fees. Look for low-cost mutual funds and ETFs to keep management fees low.
Who retains control of a 529 plan?
A 529 plan is technically a custodial account. Thus, a major custodian will control the funds for the benefit of a minor. The beneficiary can take control of 529 once they turn 18. However, the funds must still be used for eligible education expenses.
What are eligible expenses for a 529 plan?
Eligible expenses for a 529 plan include:
- Tuition fees and fees for college, graduate or professional studies
- Primary or Secondary (K-12) Tuition and Fees
- Books and school supplies
- Student loan repayment
- Off-campus housing
- On-Campus Food and Meal Plans
- Computers, internet and software used for school work (student presence required)
- Special needs and accessibility equipment for students