What is a 529 Plan?
A 529 plan is atax benefitssavings plan designed to help pay for education. Originally limited to spending on post-secondary education, it was expanded to cover K-12 education in 2017 and apprenticeships in 2019. AfterCreation of each community for the Retirement Improvement Act of 2019 (SAFE Act)andSAFE 2.0 from 2022, 529s can also be used to pay off student loans and fund a Roth IRA.
The two main types of 529 plans are education savings plans and prepaid tuition plans.
Education savings programs are on the riseDeferred taxation, and withdrawals are tax-free if used for qualified educational expenses. Prepaid tuition plans allow the account holder to pay current tuition for future tuition at designated colleges and universities. This means you can likely lock in a lower cost of college.
529 plans are also referred to as special education plans and § 529 plans.
Basic takeaways
- 529 plans are tax-advantaged accounts that can be used to pay for educational expenses from kindergarten through high school.
- There are two basic types of 529 plans: education savings plans and prepaid education plans.
- 529 plans are funded and administered by the 50 states and the District of Columbia. 529 plan rules and fees may vary from state to state.
- 529 plans can be purchased directly from a state or through a broker or financial advisor.
- Beginning January 1, 2024, up to $35,000 of remaining funds in a 529 account can be rolled over to a Roth IRA account, provided the funds are at least 15 years old.
Understanding 529 Plans
Although 529 plans take their name from Section 529 of the federal tax code, the plans themselves are administered by the 50 states and the District of Columbia.
Anyone can open a 529 account, but it is usually set up by parents or grandparents on behalf of a child or grandchild, which isrecipient. In some states, the person funding the account may qualify for a state tax credit for their contribution.
Money in a 529 plan grows on a tax-deferred basis until withdrawn. Additionally, as long as the money is used for qualified educational expenses as defined by the IRS, these withdrawals are not subject to state or federal taxes. In addition, some states may offertax deductionregarding contributions.
In the case of K-12 students, tax-free withdrawals are limited to $10,000 per year.
Since tax benefits vary from state to state, it's important to review the details of any 529 plan to understand the specific tax benefits you may or may not be eligible for.
Types of plans 529
The two main types of 529 plans have some important differences.
Education Savings Plans
529 savings plansis the most common type. The account holder contributes money to the scheme. This money is invested in a predetermined selection of investment opportunities.
Account holders can choose the investment (usually mutual funds) that they want to invest in. The performance of those investments will determine how much the account's value will increase over time.
Many 529 plans offertarget date funds, which adjust their assets as the years go by, become more conservative as the recipient approaches college age.
Withdrawals from a 529 savings plan can be used for both college and K-12 expenses. Necessary expenses include tuition, fees, room and board, and related expenses.
The SECURE Act of 2019 expanded tax-free 529 plan withdrawals to include expenses for enrolled apprenticeships and up to $10,000 in student loan debt repayment for both account beneficiaries and their siblings.
And the SAFE Act of 2022, passed as part of the 2023 Omnibus funding bill, would allow up to $35,000 of unused funds in a 529 account to be rolled over to a Roth IRA beginning January 1, 2024. To qualify, the account must be at least 15 years old.
Prepaid course plans
Prepaid tuition plansoffered by a limited number of states and some institutions of higher education. They vary in their specifications, 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 to come. Prepaid plans are not available for K-12 education.
As with 529 savings plans, prepaid tuition increases in value over time. Any withdrawals from the account used to pay tuition are not taxed. However, unlike savings plans, prepaid tuition does not cover the cost of room and board.
Prepaid tuition may place restrictions on which colleges can be used. Money in a savings plan, on the other hand, can be spent at almost any eligible institution.
Additionally, money deposited into a prepaid tuition program 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 program.
There are no limits on how much you can contribute to a 529 account each year. But many states put a limit on how much you can contribute in total. These limits have recently ranged from $235,000 to over $525,000.
Tax advantages 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.
Money you contribute to a 529 plan is not tax deductible for federal income tax purposes. However, more than 30 states provide tax deductions or credits of varying amounts for contributions to a 529 plan.
In general, you should invest in your home state plan if you want a state tax credit or credit. If you are willing to forgo a tax break, some states will allow you to invest in their plans as a non-resident.
Advantages and disadvantages of 529 plans
| Advantage | Disadvantages |
|---|---|
| High contribution limit | Limited investment opportunities |
| Flexible design page | Different fee levels by state |
| Easy to open and maintain | Fees may vary. restriction of change of plans |
| Tax deferred growth | Limitation on variable investments |
| Tax-free withdrawals | It must be used for training |
| Deductible contributions | It depends on the situation; restrictions apply |
529 Plan transfer rules
529 plans have specific rollover rules governed by the federal tax code (Section 529).
The owner (usually you) can only transfer to another 529 plan once a year, unless it's a beneficiary change. You are not required to change plans to change beneficiaries. You can transfer the plan to another family member who is defined as:
- Son, daughter, stepchild, foster child, adopted child or descendant of any of them
- Brother, sister, stepbrother or stepsister
- Father or mother or ancestor of each
- Stepfather or stepmother
- Brother's or sister's son or daughter
- Father's or mother's brother or sister
- son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law
- The wife of any person named above
- First cousin
You're not limited to investing in your state's 529 plan, but you may get a tax break for doing so. Be sure to check this plan first.
Special considerations
As with other forms of investment, the earlier you start, the better. With a 529 plan, your money will have more time to grow and grow fasteropened and financed.
With a prepaid tuition plan, you'll likely be able to keep tuition lower than what you'd pay on the street, as many schools raise their prices every year.
If you have money left over in a 529 plan — for example, if the beneficiary receives a larger scholarship or decides not to go to college at all — you have more options.
One is to change the beneficiary on the account to another relative who is eligible under the transfer rules. Another is to keep the current recipient in case they change their mind about going to college or later graduate school. If all students graduate, you can use up to $10,000 to pay off federal or private student loans for the recipient or their siblings.
A fourth option, starting in January 2024, is to rollover unused funds into a Roth IRA account if your account qualifies to do so. Finally, you can always cash out the account and pay the taxes and the 10% penalty.
How much does a 529 plan cost?
States often charge an annual maintenance fee for a 529 plan. These range from as little as $0 to $25.Additionally, if you purchased your 529 plan through a broker or advisor, they may charge up to 5% or more for assets under management.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 costs low.
Who retains control of a 529 plan?
A 529 plan is technically aescrow account. An adult guardian will thus control the funds for the benefit of a minor. The recipient can take control of the 529 when they turn 18. However, the funds must still be used for qualifying educational expenses.
What are qualified expenses for a 529 plan?
Necessary expenses for a 529 plan include:
- College, graduate or trade school tuition and fees
- Tuition and fees for elementary or secondary education (K-12).
- Books and school supplies
- Disbursement of student loans
- Off-campus housing
- Campus food and meal plans
- Computers, internet and software used for school work (requires student presence)
- Special needs and accessibility equipment for students
Bottom line
Create a 529 planoffers you a tax-advantaged way to save on education costs from kindergarten to post-secondary school, including apprenticeships. There is now a new option to move up to $35,000 of unused funds into a Roth IRA if the 529 account is 15 years old or older. With many options for using your 529 plan, they offer great flexibility and potential for tax-advantaged growth for your future scholars.