A 529 plan is an investment plan that allows you to put aside funds for certain educational expenses in an interest bearing account that grows tax-free for the life of the account. Most people create these for their children or grandchildren to pay for college.
Theoretically, you could earn tens of thousands in interest payments over an eighteen (18) year period and use those funds for college or graduate school. A new tax code change also allows 529 contributors to use the funds for private school expenses at any time.
529 plan history
Section 529 was added to the Internal Revenue Code by a 1996 piece of legislation authorizing “qualified tuition programs”, giving state programs both their popular name and tax-deferred status. Funds invested in these programs are not taxed federally when used for “qualified higher education expenses”, the definition of which has been expanded in 2015 to include computers and in 2017 to include up to $10,000 in K-12 tuition.
State plans are OK for out-of-state colleges
529 Plans can be used to meet costs of qualified colleges nationwide. In most plans, your choice of school is not affected by the state your 529 savings plan is from.
You can be a CA resident, invest in a VT plan and send your student to college in NC. Check to see if your institution is eligibleunder 529 rules.
Which states offer 529 plans?
Nearly every state now has at least one 529 plan available. It’s up to each state to decide whether it will offer a 529 plan (possibly more than one) and what it will look like, meaning 529 plans can differ from state to state.
I personally have a Vanguard 529 plan, but Fidelity also offers an easy to use plan program.
As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant.
Types of 529 plans
529 plans are usually categorized as either prepaid or savings plans.
Savings Plans work much like a 401K or IRA by investing your contributions in mutual funds or similar investments. The plan will offer you several investment options from which to choose.
Prepaid Plans let you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges.
How do I open a 529 plan?
There are two ways to enroll in a 529 plan.
- Directly with the 529 plan manager. This is what I did.
- Through a financial advisor. If you already have a financial planner, they can open an account for you right away
What can a 529 plan be used for?
A 529 plan is an investment account that offers tax-free earnings growth and tax-free withdrawals when the funds are used to pay for qualified education expenses.
For college, university and other eligible post-secondary educational institutions, this includes tuition and fees, books and supplies, computers and sometimes room and board.
The IRS also allows tax-free withdrawals of up to $10,000 per year, per beneficiary to pay for tuition expenses at private, public and religious K-12 schools.
What is not covered by a 529 plan?
The funds in a 529 plan are yours, and you can always withdraw them for any purpose.
However, the earnings portion of a non-qualified distribution will be subject to penalty and taxes if the funds are withdrawn for non-educational expenses.
Are 529 plan contributions tax-deductible?
Much like a Roth IRA, contributions to a 529 plan are post-tax, and are not deductible from federal taxes.
The primary benefit for 529 plans is that the funds in the plan grow federal tax-free and will not be taxed when the money is withdrawn for qualified education expenses.
Can I use a 529 plan to pay for rent?
Yes, room and board is considered a qualified expense if the student is enrolled at least half-time, which at most colleges and universities equates to at least six credit hours per term.
For on-campus residents, qualified room-and-board expenses cannot exceed the amount charged by the college for room and board.
For students living off-campus, qualified room and board expenses are limited to “cost of attendance” figures provided by the school. Contact your financial aid office for more information.
How do I use my 529 plan?
Once you’re ready to start taking withdrawals from a 529 plan, most plans allow you to distribute the payments directly to the account holder, the beneficiary or the school.
Some plans may allow you to make a payment directly from your 529 account to another third-party, such as a landlord.
What happens if my child doesn’t use the 529 plan?
The future is always uncertain, and some parents worry about losing the money they saved in a 529 plan if their child doesn’t go to college or gets a scholarship.
Generally, you will pay income tax and a penalty on the earnings portion of a non-qualified withdrawal, but there are some exceptions.
The penalty is waived if:
- The beneficiary receives a tax-free scholarship
- The beneficiary attends a U.S. Military Academy
- The beneficiary dies or becomes disabled
What happens to money not used in a 529 plan?
If you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:
- Change the beneficiary to another qualifying family member
- Hold the funds in the account in case the beneficiary wants to attend grad school later
- Make yourself the beneficiary and further your own education
- Roll over the funds to a 529 ABLE account, a savings account specifically for people living with disabilities
- As of January 1, 2018, parents also have the option to take up to $10,000 in tax-free 529 withdrawals for K-12 tuition
Remember, you can withdraw leftover money in a 529 plan for any reason. However, the earnings portion of a non-qualified withdrawal will be subject to taxes and a penalty, unless you qualify for one of the exceptions listed above.
If you are thinking about a non-qualified distribution, be aware of the rules and possible tactics for reducing taxes owed.
What happens if I can’t afford the monthly payments?
Most plans have minimum initial contribution requirements (sometimes as low as $25) but after that, it’s up to you.
While some families prefer to set up automated monthly deposits because they want to “set it and forget it”, others choose to make lump sum contributions around birthdays, holidays or other occasions.
With a 529 savings plan, you can contribute what you want, when you want.
Stay Rational
Plan for your children’s education
-B&T