A 529 Plan Primer

Education

A 529 Plan Primer

Let’s take a look at how this educational savings tool can help you cover expenses for higher learning while lowering your taxes.

May 11, 2016

The bottom line is 529 plans provide a tax-deferred way to save for education – for yourself, a child, grandchild or any other person you designate, with higher contribution limits and more potential benefits than an education savings account.

What are they?

  • Ways to save for higher education for yourself or someone else free of taxes.
  • Funds that can be used for qualified expenses at eligible institutions in the U.S. and some abroad including colleges, universities, vocational schools, and other postsecondary institutions.
  • State-sponsored plans made up of investment portfolios. It’s important to know that you don’t have to live in the state to select the plan, nor do you have to attend one of the state’s educational institutions – there are benefits and negatives to each plan depending on the state you live in. Before investing you should consider whether your resident state offers state tax or other benefits only available when investing in your state’s 529 plan. Plans offered by other states may not provide these same tax benefits.
  • Portfolio options usually include at least one age-based or years-to-college portfolio in addition to other pre-constructed portfolio options or customizable investment selections.

How can they be used?

  • At any eligible educational institution, meaning any private or public college, university, or technical or vocational school that qualifies for federal financial aid. Check the Department of Education’s website and click School Code Search to find qualifying institutions.
  • For qualified expenses including tuition, books, supplies and equipment required for the beneficiary’s enrollment or attendance. If enrolled at least half time, the student’s room and board can also be covered (limits are set by the educational institution).

What are their benefits?

Tax advantages - 529s can get you closer to covering college costs faster than putting money in a taxable investment earning the exact same returns.

  • Tax-deferred growth
  • Tax-free withdrawals (for qualified higher education expenses*)
  • State tax deduction in certain states
  • Reduced exposure to federal gift tax, capital gains tax and possibly estate tax

Control and flexibility - With one of the highest annual contribution maximums available, 529 plans have qualities that don’t often go hand in hand with educational savings tools.

  • Account owner maintains control for the life of the account
  • No income or age restrictions to establish an account
  • Anyone can contribute (take advantage of crowdsourcing)
  • Flexibility to change beneficiaries
  • Option to select investments
  • Low impact on financial aid eligibility

What else do I need to know?

Contribution limits

  • Maximums are established by each state’s program rules and may change each year to reflect increasing education costs, and when reached (by either contribution or appreciation), no additional contributions are allowed.
  • Contributions may be made to an education savings account and a 529 savings plan for the same beneficiary for the same tax year, as well as to a state-specific 529 prepaid plan.

Fees and expenses

  • 529s typically charge an enrollment fee, annual fee or both. Program descriptions detail additional fees that may apply.

Investment changes and considerations

  • Limited to twice per calendar year, including portfolio rebalancing.
  • If you are doing an accelerated gift (i.e., five years of gifting at one time) and the donor doesn’t survive the five-year period, a prorated amount reverts back to the donor’s taxable estate. However, no other gifts can be made to the beneficiary over the five-year period.
  • If you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings.

 

*Earnings in 529 plans are not subject to federal tax and, in most cases, state tax, so long as you use withdrawals for eligible college expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. Changes in tax laws or regulations may occur at any time and could substantially impact your situation. You should discuss any tax or legal matters with the appropriate professional. 



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