Clark Galvan
With the cost of higher education continuing to rise, many parents are turning to 529 plans to help fund their children's education. Named after Section 529 of the Internal Revenue Code, 529 plans are tax-advantaged savings plans designed to help pay for college expenses. They offer tax-free investment growth and withdrawals for qualified education expenses, which can include tuition, fees, room and board, textbooks, computers, and related costs.
Anyone can open a 529 account, but they are typically established by parents or grandparents on behalf of a child or grandchild. While there is no federal tax deduction for 529 contributions, many states offer residents a state tax deduction or credit for contributions, providing an incentive to save for college. With high contribution limits, 529 plans are a popular choice for those looking to save for future education costs.
What You'll Learn
529 plans are state-sponsored, but you can pick a plan from any state
Some states only offer their residents a state income tax deduction for contributing to their in-state 529 plan. However, nine states (Arizona, Arkansas, Kansas, Maine, Minnesota, Missouri, Montana, Ohio, and Pennsylvania) offer an income tax benefit for contributions to any 529 plan, not just the in-state one. These are also known as tax parity states.
If you relocate to a different state, you are not required to change or terminate your 529 plan. However, your ability to claim state tax deductions and tax credits may change. For most states, you can no longer claim a state income tax deduction or tax credit based on contributions to the previous state's 529 plan.
You can use a 529 plan from any state to pay for an eligible college in any state. For example, you can use a 529 plan from Ohio to pay for college in Illinois. So, you don't need to move your existing 529 plan to another state. However, you may want to channel new contributions into the new state's 529 plan to benefit from the state income tax breaks on contributions, if available.
There are a handful of states where direct-sold 529 college savings plans are available only to state residents, namely Florida, Louisiana, New Jersey, South Carolina, South Dakota, and West Virginia. The Connecticut advisor-sold plan is available only to state residents. Most prepaid tuition plans are limited to state residents.
State income tax deductions and tax credits are available only if you invest in your own state's 529 plan, except if you live in one of the nine tax parity states where a state tax break is available for contributions to any state's 529 plan.
When deciding whether to choose an in-state or out-of-state 529 plan, consider the following factors:
- The type of plan: A 529 savings plan may offer more flexibility in options when it's time for your child to go to college. For example, if they plan to attend an in-state university, a prepaid tuition plan may be an option to explore.
- Investment options: Consider your risk tolerance and plan options. Some people may choose to invest in mutual funds on an age-based sliding scale, while others may prefer higher-risk/higher-return plans.
- Taxes: Review your state's rules regarding tax benefits and compare them with other states. If your state doesn't have income tax advantages, another state's plan may have lower fees, which could be an important deciding factor.
- Fees: These can vary widely by state. According to a study from Saving for College, fees for the lowest-cost 529s for out-of-state plans range from $51 in Texas to $964 in West Virginia. Some fees may be lower for in-state residents.
- Contribution limits: Be sure to look at allowed contribution amounts. Some states have very low (or no) minimum contributions to get started, while others may have an upper limit on contributions.
- State-run or advisor-run: Some states offer 529s through financial advisors. While these plans may have higher fees, an advisor may be able to guide you toward the in- or out-of-state program that works well for your needs.
- Financial aid: Some states offer special incentives for financial assistance, especially for in-state residents using 529 plans.
- Contribution ease: Check if the plan you're considering is easy to understand and contribute to. If it feels complex or the site is hard to navigate, it may not be the right option for you.
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The account holder maintains ownership of the funds
A 529 plan is a savings plan that can provide tax-free investment growth and withdrawals for qualified education expenses. The account holder maintains ownership of the funds, meaning they can withdraw the money at any time. However, if the withdrawal is not used for qualified education expenses, taxes and penalties may apply. The beneficiary does not have control over the money in the account, even when they reach the age of majority, which is between 18 and 21 years old, depending on the state.
The account owner can change the beneficiary on the account at any time. For example, if the child decides not to pursue higher education, the account owner can change the beneficiary to a sibling or another family member. Alternatively, the account owner can roll over some of the funds into a Roth IRA for the beneficiary, with a lifetime limit of $35,000 as long as the 529 account has been open for at least 15 years.
The account owner can also choose how to invest their contributions. Most 529 plans offer a curated choice of plans, including age-based target-date funds and individual portfolios. For example, they may put 50% of their contribution into an aggressive target-date fund, 30% into an index fund, and 20% into a more conservative fund. It is important to note that there are no federal tax deductions for 529 contributions, but many states offer residents a state tax deduction or credit for contributions.
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Qualified distribution rules are strict
A 529 plan is specifically for qualified education expenses, which includes fees, room and board, textbooks, computers, and "peripheral equipment" (such as a printer). It can also be used to pay for private or religious elementary, middle, and high school tuition.
Withdrawals made for purposes outside these rules come with a price. Earnings withdrawn for non-qualified expenses are subject to a 10% penalty and ordinary income taxes. There is no penalty on the principal (the amount contributed). If you take a withdrawal from a 529, you'll need to file IRS Form 1099-Q.
Account owners can change the beneficiary on the account at any time. For example, if the child decides to take a different path, you can change the account beneficiary so that the money will go toward paying for a sibling's or other family member's education instead.
Qualified expenses for a 529 plan include:
- College, graduate, or vocational school tuition and fees
- Elementary or secondary school (K–12) tuition and fees
- Books and school supplies
- Student loan payments
- Computers, internet, and software used for schoolwork (student attendance required)
- Special needs and accessibility equipment for students
Non-qualified expenses include anything outside of the above list. For example, if you use the funds for non-education-related purposes, you will be taxed and penalized.
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Contribution limits are high
The contribution limits for 529 plans are high, allowing families to save for future education expenses. The IRS does not set the contribution limit for 529 plans, as it does for retirement accounts. Instead, states generally set the contribution limit for their 529 accounts. The IRS only stipulates that contributions cannot be more than the amount required to pay for qualified education expenses.
The contribution limits for 529 plans vary by state, ranging from $235,000 to $553,098. For example, the UNIQUE College Investing Plan offered by the state of New Hampshire has a maximum contribution limit of $553,098, the highest of all 529 plans on Forbes' list. This high contribution limit can be beneficial if your child attends graduate school in addition to undergraduate studies.
There are no eligibility requirements or income limits for contributing to a 529 plan, making it accessible to anyone who wants to save for future education expenses. Additionally, there is no federally mandated minimum deposit required to open a state-administered 529 plan, although each state sets its own minimum requirements, ranging from $0 to $3,000.
The high contribution limits of 529 plans make them a popular choice for parents, guardians, and anyone else who wants to save for a loved one's future education. The tax advantages, compounded returns, and the potential for a state tax deduction on contributions further add to the appeal of 529 plans.
The account owner can be the beneficiary
A 529 plan is a great way to save for your future educational expenses or that of your child. The account owner can be the beneficiary, and they can open a 529 plan for themselves or a beneficiary such as a child or other relative. If you are opening an account for someone else, you will need their Social Security number, date of birth, and address. You will also need your bank information, including your routing and account numbers, for funding and setting up automatic deposits.
The process of opening a 529 plan is simple and can be done online. You will need to gather your information, choose your 529 plan, and select your investments. You can open a 529 account online and fund it directly from your bank account. It is important to read over your account agreement to understand any fees and other details.
A 529 plan is a tax-advantaged savings account, and the money you invest will grow tax-free if used for eligible education expenses. These expenses include tuition, fees, room and board, textbooks, computers, and related costs. The funds can also be used for K-12 tuition, apprenticeship costs, and student loan repayment of up to $10,000 per beneficiary and each sibling.
There are two main types of 529 plans: college savings plans and prepaid tuition plans. College savings plans offer tax-deferred growth, with tax-free withdrawals for qualified education expenses. Prepaid tuition plans allow you to lock in current tuition rates for future attendance at selected colleges and universities.
When choosing a 529 plan, consider the investment options available, such as age-based target-date funds or individual portfolios. You can also put your contributions into multiple accounts to diversify your investments. It is important to review the costs, tax benefits, and features of different plans to find the best fit for your long-term savings goals.
By setting up a 529 plan, you can take advantage of the tax benefits, compounded returns, and the ability to maintain ownership and control over the funds. It is a flexible and powerful tool for saving for future education.
Frequently asked questions
The biggest reasons are the structured savings and the tax benefits. A 529 plan gives you the benefit of tax-free growth on investments and a potential state tax break.
Some consumers may be concerned about the possibility of losing money on their contributions. However, it's best to start saving in a 529 plan early, as this gives your money more time to grow.
Money in 529 plans must be used to pay for qualified education expenses. You can always take the money out to pay for other expenses, but you'll pay federal income tax and a 10% penalty. You also have other options, such as transferring the money to another beneficiary or using it to pay off existing student loans.
It's possible to lose money in a 529 college savings plan, as your savings will increase or decrease based on the performance of your investments. Opting for a diversified portfolio can help reduce your risk of losing money.
