What is a 529 Plan?
A 529 plan is an investment account that offers tax-free withdrawals and other benefits when used to pay for qualified education expenses. You can use a 529 plan to pay for college, K-12 tuition, apprenticeship programs, and even student loan repayments. Any leftover funds can be used in different ways, including funding a Roth IRA.
Who can use a 529 plan and what can it be used for?
A 529 plan can be used to save for certain educational expenses for any student in your family, including yourself. These educational expenses include college or other post-secondary education (qualified higher education expenses), as well as tuition for elementary or secondary public, private, or religious schools. Education savings plans can also be used to pay for certain expenses required for participation in registered apprenticeship programs and qualified education loan repayments up to $10,000 total per beneficiary.
The person who opens the 529 plan account is called the account holder or the saver. The person the account is opened for is called the beneficiary or the student. The account holder and the beneficiary can be the same person.
When should I start saving in a 529 plan account?
You should consider saving as early as you can, taking into account your family’s overall financial situation and other financial goals you may have. One of the benefits of 529 plans is the tax-free earnings that grow over a period of time. The longer the money is invested, the more time it has to grow and the greater your tax benefits. You will lose some of these potential benefits if you withdraw money from a 529 plan account within a short period of time after it is contributed.
Should I save through a 529 plan or are there other ways to save for an education?
Investing in a 529 plan is only one of several ways to save for an education. Other tax-advantaged ways to save for an education include Coverdell education savings accounts, Uniform Gifts to Minors Act (UGMA) accounts, Uniform Transfers to Minors Act (UTMA) accounts, tax-exempt municipal securities, and savings bonds. Saving or investing for an education in a taxable account or with other types of investments are also options. Each option for saving for an education has advantages and disadvantages and may have a different impact on your student’s eligibility for financial aid and your tax situation. For additional information on tax implications, please consult a tax adviser.
If I choose a 529 education savings plan, which plan should I choose?
You can invest in almost any state 529 education savings plan or even in multiple plans regardless of where you live. You should compare plans to determine which one is right for your family, but a good place to start is your state’s plan. Many states offer tax incentives or other benefits for their residents. Make sure you do your research because these benefits vary depending on the state and the 529 plan. In addition, state and federal laws that affect 529 plans could change.
But don’t stop there. There can be significant differences in costs from plan to plan, so find out how your in-state plan compares on costs. Investing in a lower-cost “out of state” plan may outweigh the benefits of investing in a higher-cost in-state plan, even taking tax incentives or other benefits into consideration.
Finally, there may be reasons other than fees and residency benefits that make one plan more desirable for your family. These could include the investment options available or the ability to change the account holder or beneficiary.
You should understand all of the limitations or restrictions of any plans you are considering.
What can I do if my student didn’t use all the money in the 529 account?
Some families may end up with money in a 529 account after their student is finished with school. If you use the money for purposes other than paying for qualified higher education expenses or the other expenses detailed above, the earnings portion of these withdrawals will be subject to federal income tax as well as a 10% penalty. These withdrawals may also be subject to state income tax if you claimed a deduction or credit for your contributions. If your student received a scholarship, you can generally withdraw money from a 529 account up to the amount of the scholarship without a penalty, but you will still have to pay taxes on any income earned.
You may be able to avoid paying any penalties and taxes if you change the beneficiary of the 529 account or transfer the assets to another 529 account, but the recipient in both instances would need to be a person in the same family. Or you could keep the savings in the 529 account if your student is considering graduate school. In addition, you can rollover funds in a 529 account into a Roth IRA account for the same beneficiary. These rollovers have some restrictions. For example: the total rollover amount is limited to $35,000; annual Roth IRA contribution limits apply; the 529 account must have been open for at least 15 years; and the funds you rollover must have been in the 529 account for at least five years. Make sure you understand the tax implications of investing in a 529 account and consider whether to consult a tax adviser.
