What is a 529 plan?
529 plans are tax-deferred accounts designed specifically for education savings. They are offered by individual states, but you do not have to be a resident of a particular state to invest in that state's plan. Withdrawals, if used for “qualified educational expenses” are exempt from state and local income tax – this includes any earnings that have accumulated within the 529 account over the years. Investors should consider, before investing, whether the investor's or the designated beneficiary's home state offers any tax or other benefits that are only available for investment in such state's 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors.
Traditional costs such as tuition, room, board and books at accredited colleges, trade or vocational schools are considered “qualified expenses”. Recently, the list of qualified expenses has expanded to include such items as computers, laptops and even internet services for students.
What expenses are covered by 529 plan withdrawals?
What about K-12 expenses?
Additionally, as of 2018, depending on your state, $10,000 per year can be applied toward tuition for K-12 schools. Although the money may come from multiple 529 accounts, it will be aggregated on a per beneficiary basis, and any distribution amount in excess of $10,000 will be subject to income and a 10% federal penalty tax.
No, you will not receive an immediate federal income tax deduction on your contributions. However, depending on your state, you may be eligible for a state income tax deduction on your contributions. For example, the state of Michigan offers a state tax deduction on up to $10,000 contributed in any given year to a Michigan 529 plan.
Do I receive an immediate tax-deduction for 529 contributions like a 401k?
Do I have to invest in my state’s sponsored plan?
No, you may choose any state’s plan as you see fit, regardless of your residence or beneficiary’s school choice. However, it is important to note that you won’t receive a state tax deduction (if your state offers one) if you don’t invest in your state’s plan. Generally, the longer the time horizon until these funds are used, the less important the state tax benefit becomes.
How are 529 plans different than Uniform Gift/Transfer to Minors Act (UGMA/UTMA) Accounts?
529 plans were created in 1996. Prior to then, UGMA and UTMA accounts were really one of the only vehicles to save for higher education. The main difference between the two is that by law, upon age 18 (or 21, depending on your state), funds within an UGMA or UTMA account must go to the beneficiary and he or she can use the funds however they please. A 529 plan on the other hand, is completely controlled by the account owner for the duration of the owner’s life or until he or she transfers ownership to someone else. In addition, UGMA/UTMA accounts do not offer tax-deferral while funds are accumulating like the 529 plan does.
Most 529 plans offer a number of investment options, including “age-based portfolios. These investments are quite popular because they are very “low maintenance”. The investment allocation of the portfolio is based on the beneficiary's age and the number of years he or she has until they start school. These funds will rebalance and become more conservative as the beneficiary approaches their target date – similar to how one typically reduces risk as they near retirement. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state. Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. This and other information about 529 plans is available in the issuer's official statement and should be read carefully before investing. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.
How are 529 plans invested?
529 plans offer significant flexibility should the designated beneficiary decide not to attend college, or if the funds are not used for other qualified educational expenses. You can take out the money as a non-qualified withdrawal, but any earnings on non-qualified distributions are subject to tax as well as a 10% penalty. You would not, however, pay tax or penalties on the dollars you actually contributed to the plan. Another benefit of the 529 plan is that you can change the beneficiary on the account to eligible family members of the original beneficiary without incurring any tax or penalty.
What happens if my child doesn't attend college or I don’t use all the money in the account?
An account holder can open a 529 account for the benefit of any potential student. For example, parents can save on behalf of a child and grandparents can save on behalf of grandchildren. Generally anyone can be the beneficiary of a 529 account regardless of their relationship to the person who establishes the account, as long as the beneficiary is a US citizen or resident alien.
Who can contribute to a 529?
In most cases, contributions should not exceed the amount necessary to provide for the educational expenses of the designated beneficiary. Also important is that there may be gift tax consequences if you contribute more than $18,000 (2024 annual gift exclusion amount) to a designated beneficiary in one year. Also unique to 529 plans, a single person may contribute up to 5 years’ worth of annual gifts in a single lump sum ($90,000) without eating into one’s lifetime gift exemption amount (this amount can be doubled for married couples). Any contribution above the annual gift exclusion amount of $18,000 will require the filing of a gift tax return (Form 709).