What is a 529 Plan?
529 plans are state government-run, tax-advantaged methods of saving for higher education such as college or vocational school. They are called 529 plans because these types of accounts were created and government-authorized in Section 529 of the Internal Revenue Code. There are many names for 529 accounts – 529 college savings accounts, 529 savings plans, 529 plans, so on and so forth.
Currently, 529 plans consist of two options: (1) an education savings plans, and (2) prepaid tuition plans.
Today is 529 Day!
May 29th has become the official day to raise national awareness for 529 accounts, which are one of the most popular ways of saving for college: (so clever…May 29 = 5/29). These plans help you manage future tuition and other costs associated with higher education. But what exactly are they all about? That’s where we can help. Read on to learn everything you need to know to decide whether or not these plans are right for you.
Types of 529 College Savings Accounts
The 529 education savings plan is an investment account that you can use to save for future college expenses (tuition, room & board, books, etc). You name a beneficiary on the account, which is typically your child (or grandchild, etc), but technically you can name anyone – even yourself – as a beneficiary. Money inside this account can be invested in stock and bond funds, though you are limited to the options provided by your state’s plan (similar to how your 401k works). Once the child goes to college, you can then use it to pay for qualified expenses tax-free.
The 529 prepaid tuition plans, on the other hand, is exactly what it sounds like. The prepaid plan lets you buy tuition credits for public, in-state colleges at their current price. When the beneficiary starts college you can then cash-in these credits to pay for tuition, room & board, books, etc. If your child ultimately attends a private or out-of-state institution the credits can still be cashed-in but it will unfortunately be at a discounted rate, meaning you have to cover the difference out of pocket. Note, due to soaring tuition costs the state of Virginia has temporarily shut down its prepaid plan to new applicants; other states may likely do the same.
You may have also heard of 529 ABLE accounts, which are similar to college savings plans. However instead of higher education expenses, 529 ABLEs cover qualified expenses for disabled individuals. We will cover 529 ABLEs in more detail in a later blog.
Advantages of 529 Plans
1. Savings grow tax-free. You never pay taxes on investment earnings or on money withdrawn for qualified expenses (see our free decision tree called Are 529 Plan distributions taxable? to help you figure it out). If you take out money for non-qualified purposes it will be taxed at your ordinary income tax rate plus an extra 10% penalty. Examples of qualified expenses are tuition, books, and room & board. Examples of non-qualified expenses are extra-curriculars and travel to and from the college (i.e. you can’t use a 529 to pay for plane tickets to send your kid back to school). For more information, check out this chart of qualified education expenses. As technology and the higher education landscape change, more costs may attain qualified status. For example, computers were added in 2015 since they are an essential part of receiving an education today.
2. You can invest in any state’s plan. You do not have to live in the corresponding state. Virginia has the largest plan out there, so you can take advantage of it regardless of where you live. Learn more about Virginia’s 529 plan.
3. Virginia’s plan offers a tax deduction for residents. If you are a Virginia resident and contribute to a 529 account, you can deduct up to $4,000 per account from your taxes for contributions made during the year. Many other states offer this perk, so if you don’t live in Virginia research your state’s rules.
4. You don’t even have to think about it. These plans are a simple, easy way to save for college. You can even set up automatic recurring contributions from a checking account.
5. Anyone is eligible. There are no age or income limits unlike other college savings vehicles such as Roth IRAs and Coverdell Education Savings Accounts. Note, due to gift tax rules there are limits on how much you can save in the account each year (and in total). Check with your tax advisor to see if this impacts you.
6. The donor has exclusive control. The funds are yours alone – meaning you get to decide how and when money is disbursed, unlike other accounts such as UTMAs that become the legal property of the child at a certain age (usually 18). With 529s, if the beneficiary does not go to college the account owner can just change it to another child tax-free. Worst case, if none of your kids attends college you can always take the money back (albeit with taxes and a penalty), or even save it for a future grandchild down the road.
529 plans can help students receive a higher education. Tax-free growth, flexibility, and the many other benefits make it nearly a no-brainer. However, you should still research different state plans and what they have to offer. Which type of plan, education savings or prepaid tuition, will work best for the beneficiary? Consider which colleges and universities participate in prepaid plans. It’s not something to be entered into lightly, but it can help you manage your child or other beneficiary’s educational future.
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