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Eight Answers to Questions About 529s

Life Stage Insights

Life Stage Insights

Eight Answers to Questions About 529s

529 plans can be a great way to save for education expenses, but there are important questions to ask before setting one up.

Introduction

A 529 plan is a tax-advantaged investment vehicle that can be a powerful way to accelerate savings for education expenses. These plans are named after Section 529 of the Internal Revenue Code. They were first established in 1996 and in recent years the benefits and scope of 529 plans have been expanded.


There are two types of 529 plans. College Savings Plans invest after-tax contributions in mutual funds or similar investments. Prepaid Tuition Plans allow families to pre-pay the costs of in-state public college education, but can also be converted for private and out-of-state colleges.


What can a 529 plan be used for?

529 plans can be used to pay for both public and private college costs at any qualified college nationwide. You can use your 529 plan at more than 6,000 U.S. and 400 foreign colleges and universities. The plans can also be used for K–12 public, private, and religious school tuition. 


Qualified expenses generally include tuition and fees, school supplies, and room and board. Student debt repayments are also a qualified expense for 529 accounts.


How is a 529 plan set up?

Anyone is eligible to take advantage of a 529 plan, and there are generally no income limitations or age restrictions. Parents, grandparents, and even family friends can contribute. There are several steps to setting up a 529 plan. How the plan is set up and how much it is funded should be considered in context of both education needs and your overall financial goals and resources. You can invest in almost any state 529 plan, not just your own state’s 529 plan. After selecting the most appropriate 529 plan, the you can enroll and make a contribution, or sign up for automatic deposits. The fund investments are managed by the plan, not by the donor.


What are the tax benefits of 529 plans?

Like a Roth 401(k) or Roth IRA, contributions to a 529 plan are post-tax and are not deductible from federal income taxes. However, many states offer state income tax deductions or credits.


The most significant tax advantage is that earnings accumulate tax-free and withdrawals are federally income tax-free if they are used for qualified education expenses.


For non-qualified withdrawals, the earnings portion is subject to income tax and an additional 10% penalty tax.


Are there 529 plan contribution limits?

Contribution limits vary by state but are typically over $235,000, and the federal gift tax exclusion allows up to $15,000 per year per beneficiary, or $30,000 for married couples. Contributions from friends or other family members are considered gifts and count toward the annual gifting limit.

Through the accelerated giving provision, you can also give up to five years of gifts in one year, and that amount is generally not considered to be a part of your estate for federal estate tax purposes.


How do I use my 529 plan?

Once the beneficiary starts their education, withdrawals from a 529 plan can generally be used for payments directly to the account holder, school, or beneficiary, though rules vary by state and plan.


What happens if my child doesn't use the 529 plan?

If your child does not use the 529 plan as intended, you may be subject to income tax and a penalty for non-qualified withdrawals. However the penalty is waived if the beneficiary receives a tax-free scholarship, attends a U.S. Military Academy, or the beneficiary dies or becomes disabled


You can avoid paying taxes and a penalty by changing the beneficiary to another qualifying family member or yourself, keeping the funds in the account for future education needs, or rolling the funds to a 529 ABLE account, a savings account specifically for people living with disabilities


Who controls the account?

The donor, not the beneficiary, maintains control of the account, and in most cases donors can reclaim the funds for their own use.


Does a 529 plan impact financial aid?

Whether the 529 plan is owned by the parent or the student, it is considered a parental asset and  generally has little impact on financial aid.

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Disclosures

This publication is designed to provide general information and is for discussion purposes only. The effectiveness of any strategy is dependent upon each individual’s facts and circumstances. This article does not provide legal, tax or account advice. Because of the possibility of human or mechanical error, the accuracy, adequacy, completeness or availability of any information is not guaranteed.

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