Understanding 529s

A 529 plan is a state-sponsored, tax-advantaged education savings account that offers tax benefits and spending options. They’re one of the most popular education savings account types in the U.S. It’s named after Section 529 of the Internal Revenue Code, which created these plans in 1996. There are two types of 529 plans – education savings plans and prepaid tuition plans.

Prepaid Tuition Plans

Prepaid tuition plans allow families to pay tuition ahead of time for specific colleges or college systems at today’s tuition rates. Not every state offers a prepaid tuition plan. You can check with your state to see if it offers a prepaid tuition plan. Most state prepaid tuition plans require you or the student beneficiary to be a resident of the state offering the plan. The cost of the plan depends on the age and grade level of the student beneficiary when you purchase the plan. Some states also have age or grade limits for beneficiaries at the time of enrollment.

Education Savings Plans

These work similarly to a retirement account, where you contribute money that gets invested. Hands-on investors can strategize and choose an asset mix of equities and fixed income that fits their (or the beneficiary’s) timeline and risk tolerance. Alternatively, 529 plans offer Target Date Funds, which automatically adjust to become more conservative as the beneficiary approaches their enrollment date.

Five Benefits of a 529 Plan

1. Tax Advantages

  • Tax-Free Growth: The money you invest in a 529 plan grows tax-free, meaning you won’t pay taxes on earnings as long as you use the funds for qualified education expenses.
  • Tax-Free Withdrawals: When you withdraw money to pay for qualified education expenses, such as tuition, books, and room and board, you don’t pay federal taxes on those withdrawals. Some states also offer tax deductions or credits for contributions to their 529 plans.
flowchart for understanding federal tax implications for 529 withdrawals

2. Flexibility

  • Broad Use: Funds can be used at most accredited colleges and universities in the U.S., including vocational and technical schools. Some plans even cover K-12 tuition (up to $10,000 per year) and certain apprenticeship and trade school programs.
  • Transferable: If the beneficiary (the person the plan is intended for) decides not to pursue higher education, you can transfer the funds to another family member without penalty. This includes siblings, cousins, parents, and even yourself.
  • The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 and the SECURE 2.0 Act of 2022 permitted 529 funds to be used for student loan repayment, up to $10,000 in student loan debt repayment for account beneficiaries and their siblings. Further, the SECURE Acts allows up to $35,000 of leftover funds in a 529 account can be rolled over into a Roth individual retirement account (IRA), provided the 529 account is at least 15 years old.

3. High Contribution Limits

Generous Limits: 529 plans generally have high contribution limits, often exceeding $300,000 per beneficiary. This allows you to save a substantial amount over time. Note: In 2024, the annual gift tax exclusion has increased to $18,000, up from $17,000 in 2023. This means that you can give up to $18,000 per year to any individual without it counting against your lifetime gift tax exemption, which has also increased to $13.61 million for single filers and $27.22 million for married couples filing jointly, up from $12.92 million and $25.84 million in 2023, respectively.

4. Parental Control

Account Ownership: A 529 plan is technically a custodial account, so an adult custodian controls the funds for the benefit of a minor. The beneficiary can assume control over the 529 once they turn 18. However, the funds must still be used for qualifying education expenses.

5. Low Impact on Financial Aid

Money in a 529 plan is considered a parental asset on the FAFSA (Free Application for Federal Student Aid), which typically has a smaller impact on financial aid eligibility compared to assets owned by the student.

More Resources About 529s

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