A 529 plan is a tax-advantaged savings plan that helps cover education expenses. It has evolved to include student loan repayment, apprenticeship programs, and the option to convert unused funds to a Roth IRA in recent years.
The 529 savings plan allows contributions to grow tax-deferred. Money can be withdrawn tax-free for qualified education expenses like tuition, fees, room and board, and books at various educational institutions. Originally designed for college expenses, 529 plans can now also be used for K-12 tuition and apprenticeship programs.
So, what exactly is a 529 plan? Here’s a guide to understanding 529 plans and leveraging them for your children’s future college savings goals.
529 plans: Understanding these tax-advantaged education savings accounts
A 529 plan enables a participant to create a tax-advantaged account for a beneficiary to use for education expenses. After-tax money is deposited into the account, which can then grow tax-deferred and be withdrawn tax-free for qualified expenses.
Contributing to a 529 plan may offer tax benefits in some cases. Some states provide tax deductions on contributions, and tools like Vanguard’s 529 state tax deduction calculator can help determine potential benefits. Contributions are made with after-tax funds, so they do not qualify for federal tax deductions.
Anyone can open and contribute to a 529 plan, including parents, grandparents, and relatives. The account can even be used to fund the account holder’s own educational expenses. Depending on state law, you may be able to claim a tax deduction for your contribution even if you’re not the account owner.
When withdrawing money from a 529 plan, it should be used for education expenses in the same calendar year to avoid penalties. Keeping receipts is recommended in case of IRS scrutiny.
Each state’s 529 plan offers different benefits, so it’s essential to research and choose the plan that best suits your needs. Look for plans with low costs, good investment returns, and favorable benefits. Familiarize yourself with the specific rules of your chosen plan.
Exploring the different types of 529 plans
There are two main types of 529 plans: prepaid tuition plans and education savings plans. Each type serves different purposes and offers distinct investment options.
- Prepaid tuition plans allow the purchase of college tuition credits at today’s prices for future use. These credits can only be used at participating colleges and universities for the beneficiary and typically do not cover room and board or primary and secondary school expenses.
- Education savings plans are more versatile, allowing individuals to open an investment account for future education expenses. These plans cover tuition, fees, room and board, books, and other qualified costs. They can usually be used at most U.S. colleges, universities, K-12 private schools, and other programs.
Education savings accounts can be invested in various assets, including stock funds for higher returns or bond funds for lower risk. However, investments in the market are not federally or state-insured.
Tax and financial aid advantages
529 plans offer several tax and financial aid benefits:
- Tax-deferred growth allows contributions to grow without tax implications until withdrawal. In 2024, individuals can contribute up to $18,000, or $36,000 for joint filers, per beneficiary without filing a gift tax return, subject to state-specific rules.
- Tax-free withdrawals for qualified education expenses make earnings tax-free if used appropriately.
- Potential state tax deductions can result in tax savings if your state offers deductions. However, deductions may vary by state taxation laws.
- Flexible beneficiary options enable 529 plans to benefit multiple children over time if managed strategically.
- Student loan repayment allows up to $10,000 per lifetime for the beneficiary’s student loans and additional amounts for siblings. Be aware of potential tax implications based on state guidelines.
- Parent-owned accounts impact financial aid less compared to child-owned assets, potentially affecting financial aid eligibility positively.
- Rollover to a Roth IRA permits unused funds in a 529 plan open for at least 15 years to be rolled over into a Roth IRA for the beneficiary, with certain limitations.
Utilizing a 529 plan for multiple children
A single 529 plan can benefit multiple children by changing the beneficiary after the first child’s education. However, consider the remaining funds for subsequent children and potential investment strategy adjustments.
Having separate 529 plans for each child might be more advantageous in some situations, allowing better record-keeping and potential state tax deductions.
Understanding qualified expenses for a 529 plan
529 plan funds can be withdrawn tax-free for qualified education expenses. Expenses not meeting IRS criteria for qualified expenses may incur penalties upon withdrawal.
Qualified expenses typically include tuition, fees, textbooks, room and board, computers, apprenticeship costs, K-12 private education, special needs services, and student loan repayment, among others.
However, expenses like transportation and extracurricular fees are generally not covered by 529 plans.
Starting a 529 plan
Opening a 529 plan can be done directly through a state plan or with the assistance of a broker or financial advisor.
- Directly through a plan’s website: Register, choose investments, and manage the plan independently over time.
- With a broker or financial advisor: Delegate plan selection, investment decisions, and ongoing management, but be prepared for potential fees or commissions.
Fidelity Investments and Charles Schwab are popular options for opening 529 plans, especially if you already have accounts with these firms.
Using a 529 plan at different colleges
529 savings plans are generally accepted at qualified colleges nationwide, regardless of the sponsoring state. However, prepaid tuition plans may have limitations on eligible colleges.
Verify the eligibility of your chosen institution before using 529 plan funds.
Unused 529 plan funds
If a beneficiary does not use the 529 plan, the beneficiary can be changed to another family member who can utilize the funds. Funds can be held indefinitely as long as a living beneficiary is designated.
After 15 years, unused funds can be rolled over to a Roth IRA for the beneficiary, with specific limits. If funds cannot be used, withdrawals may incur taxes and penalties, although certain exceptions exist, such as scholarships, military academy attendance, disability, employer assistance, or beneficiary death.