529 Plan Highlights

June 15, 2023

Presented by Rich LeBranti

What is a 529 Plan?

A 529 Plan is a tax-advantaged savings plan designed to help you save in advance to pay for college expenses like tuition, books and campus housing. These plans are either “prepaid” which is school-specific, or “savings” plans which are more common, are professionally managed, and invest in the market.

Benefits of the 529 Savings Plan

529 plans offer attractive tax benefits. Any contributions you make to the 529 plan are invested and earnings grow tax-exempt. Your withdrawals are tax-free if they are used to pay qualified tuition expenses. If you use the money on non-qualified expenses, you will owe income tax and a 10% penalty on these non-qualified withdrawals.

Most people think of a 529 plan as being exclusively for college-related expenses, however funds can be used to pay for expenses at any educational institution that participates in a financial aid program managed by the US Department of Education. This includes four-year universities, community college, trade schools, technical schools, and culinary schools.

Examples of qualified expenses include tuition, mandatory fees, books, supplies, computers, internet access, room, and board. The Tax Cuts and Jobs Act also expanded 529 plan benefits so that you can now use 529 funds in part to fund private, public or religious K-12 schools. See more on Qualified and Non-Qualified expenses.

Some states also offer tax benefits in the form of tax-deductible contributions or tax credits. More than 30 states currently offer these benefits.[1]

How 529 Plans are Managed

You don’t need to know about investing in order to open a 529 account. Most plans offer age-based portfolios. You simply choose the year in which the student will begin to withdraw for educational expenses, and the fund is managed appropriately so that as your student gets closer to college age, the portfolios are invested in less risky investments.

Many plans also offer a low minimum initial investment, sometimes as little as $25 to open an account. You can sign up to make contributions electronically from your checking or savings account to make it easy to contribute regularly. Relatives and friends may also contribute to a 529 Plan for your student via an online link, making gifting easy.

Each state sets its own 529 plan contribution limit which typically ranges from $200,000 to more than $500,000. This is in excess of the current $17,000 federal gift tax exclusion, yet the IRS does allow large contributions to be spread out over five years when filing a return, allowing for a one-time contribution of $85,000 to not trigger the gift tax. Be sure to discuss this option with your tax preparer before making a large contribution to a 529 account.

How 529 Plans Affect Scholarships and Financial Aid

529 Plan funds do not affect partial scholarships. In the event your student gets a partial scholarship, funds from the 529 can help reduce his or her college costs all the more. If your student receives a full scholarship, you don’t need to give up all of your 529 benefits. 529 Plan balances can be transferred to another beneficiary such as a sibling, child, or cousin, as long as certain conditions are met. The IRS also allows you to make a penalty-free non-qualified withdrawal in the amount equal to the tax-free scholarship, though you will likely still owe federal and state income tax on the withdrawal.

When it comes to financial aid, 529 plan assets affect a child’s financial aid eligibility to a small degree if the owner is both the custodial parent and account holder. In this case, the federal government counts only up to 5.64% of the account’s value into the student’s Expected Family Contribution (EFC). This formula determines a student’s federal financial aid eligibility. However, if the student serves as the account owner, the government factors a larger cut of up to 20% into the EFC.

If the account owner is someone else such as an uncle or a grandparent, the plan will not count as an asset. However, withdrawals from the plan to cover the student’s education will count as the student’s untaxed income when he or she fills out future Free Application for Federal Student Aid (FAFSA) forms.

If your student decides not to attend school or take time off from education, a 529 account does not expire. Your money stays in the plan until your student is ready to use it.

What You Will Need to Open a 529 Account

You need to be 18 or older with a valid Social Security or tax identification number to open an account. You need not be restricted to 529 plans in your own state but can shop around to see which plan offers the 529 plan that works best for you.

A 529 Plan provides a tax-advantaged way to save for higher education expenses for yourself and the students in your life. This article is intended to give you an overview of the benefits of 529 plans. If you are considering opening a 529 account, be sure to conduct your own due diligence and talk with your advisor or CPA to determine whether a 529 account is best for you.

[1] Currently the following states offer either a tax deduction or tax credit for 529 contributions: AL, AZ, AR, CO, CT, DC, GA, ID, IL, IN, IA, KS, LA, ME, MD, MI, MN, MS, MO, MT, NE, NM, NY, ND, OH, OK, OR, PA, RI, SC, UT, VT, VA, WV, WI

The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.

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