Beginner's Guide to 529 Plans

The cost of a college degree has increased over 65% since 2001. Many parents feel their children will graduate with debt just like they did. A 529 plan could be the key to confidently securing your child's future education. Few people are aware of all the rules and benefits of these plans. This newsletter is the perfect quick start to 529 Plans.

What is a 529 Plan?

• A state-sponsored investment account specifically designed for education savings, but with lots of flexibility!

• Contributions can grow tax-free and withdrawals are tax-free when used for qualified education expenses.

There are two types of plans

• Prepaid Tuition Plan - You pay for tuition, measured in years, credits or units (depending on the state) in one lump sum or through installment payments. This plan allows parents to lock in tuition costs at their current rates and avoid costs increases through the years. The catch is, these plans typically limit the benefit to schools within the state that is offering that particular plan.

• College Savings Plan - These are structured like other retirement-like accounts. You invest in index and/or mutual funds and the funds are available for you to withdraw at anytime for qualified expenses.

Contributions🤲🏽

There is no limit to what you can contribute to a 529 plan. However only $18k per donor will be excluded from gift taxes. Anything above that limit will count against the lifetime gift tax exclusion limit.
(Introduction to gift taxes: Video, Newsletter)

Married couples count as separate donors. They are able to give $18k each to each child. That’s up to $36k per year without triggering a gift tax.

These contributions may be deductible for state taxes but are not deductible for federal taxes. (check with your state’s plan)

If you want to make a large contribution and avoid gift tax implications, you can contribute up to $90k at one time as a front-load contribution. This eliminates the ability to contribute anything to the plan for the next 5 years. ($18k*5=$90k)

Withdrawals 🤑

529 plan distributions are tax and penalty free if used for qualified expenses which are necessary for enrollment and attending the education institution.⬇️

Expenses for College:

• Tuition

• Fees

• Books

• Supplies and equipment

• Computers and software

• Internet access

Other Qualified Expenses:

• All the expenses listed above for K-12 education, up to $10k per year per child.

• Apprenticeships registered with the Secretary of Labor.

Transfers 💸

The IRS continues to make 529 plans flexible. If there are funds left once your child is done with college, or chooses not to go, here are your options for transfers:

• Roth IRA - A total of $35k can be transferred to a Roth IRA from a 529. These are limited to the IRA contribution limits, currently $7k annually.

• ABLE Accounts - Rollovers are subject to the annual contribution limit of $18k. (for dependents with disabilities)

• Family Members - 529s can be designated to a new beneficiary within the original beneficiary’s family.

Another option is to let the funds sit. 529 plans have a unique benefit that other custodial accounts don’t. As the custodian, the funds remain in your custody until you chose to distribute the funds. You can allow the funds to remain invested within the plan as long as you want. This gives the person who created the account ultimate flexibility on the use of the funds.

Taxes ⚖️

Contributions

Contributions to 529 plans are done with after-tax dollars. The IRS does not give a deduction for putting money in the plan. However, once in the plan, the amount you invest won’t be taxed again. It is only possible for the earnings to be taxed. (see below for more details)

Some states allow deductions for amounts invested in the plan. Most states limit the deduction to $5k.

Distributions

If the amounts taken out of the 529 plan are for qualified expenses, there is no tax on the earnings of the investments. Note: the taxed amount will only include the earnings of the investment and never the contributions since those were made from after-tax dollars.

There are two scenarios where you’ll owe taxes on the investment earnings:

• When money is taken out and not used for qualified expenses.

• When the money taken out of the 529 plan is in excess of the amount of the qualified expenses due to other tax-favored or tax-free education benefits. Think American Opportunity Tax Credit, Lifetime Learning Credit and Coverdell education savings.

Hopefully this general overview of 529 plans helpful. Stay tuned for more detailed information regarding education savings. 👀

Resource:
- This link provides each state’s 529 Plan website along with state specific contributions limits ➡️ HERE!

Disclaimer: This is not financial advice. This newsletter is for educational purposes only. Consult your financial advisor for specific financial advice. This guide provides a general overview of 529 plans. The information is based on the IRS rules as of tax year 2024.