What is a 529 Plan?
A 529 plan is a tax-advantaged investment vehicle in the U.S. designed to encourage saving for the future higher education expenses of a designated beneficiary.
The name “529” comes from Section 529 of the IRS tax code, which gives these plans special tax breaks to encourage saving for education. Sponsors include states, state agencies, or educational institutions.
Savings can be used for tuition, books and other education-related expenses at eligible two- and four-year colleges and universities, US vocational-technical schools, and eligible foreign institutions.
What fees and expenses will I pay if I invest in a 529 plan?
It is important to understand the fees and expenses associated with 529 plans because they lower your returns. Fees and expenses will vary based on the type of 529 plan (education savings plan or prepaid tuition plan), whether it is a broker- or direct-sold plan, the plan itself and the underlying investments. You should carefully review the plan’s offering circular to understand what fees are charged for the plan and each investment option.
What types of investments can I use?
A saver may typically choose among a range of investment portfolio options, which often include variousmutual fundsand exchange traded funds (ETF) portfolios and a principal-protected bank product. These portfolios also may include static fund portfolios and age-based portfolios (sometimes calledtarget-dateportfolios). Typically, age-based portfolios automatically shift toward more conservative investments as the beneficiary gets closer to college age. If you are using a 529 account to pay for elementary or secondary school tuition, you may have a shorter time horizon for your money to grow. You also may not feel comfortable taking on riskier or more volatile investments if you plan on withdrawing the money soon. Because of these things, you may consider different investment options depending on when you plan to use the money that is invested.
All education savings plans are sponsored by state governments, but only a few have residency requirements for the saver and/or beneficiary. State governments do not guarantee investments in education savings plans. Education savings plan investments in mutual funds and ETFs are not federally guaranteed, but investments in some principal-protected bank products may be insured by the FDIC. As with most investments, investments in education savings plans may not make any money and could lose some or all of the money invested.
How does investing in a 529 plan affect federal and state income taxes?
Investing in a 529 plan may offer savers special tax benefits. These benefits vary depending on the state and the 529 plan. In addition, state and federal laws that affect 529 plans could change. You should make sure you understand the tax implications of investing in a 529 plan and consider whether to consult a tax adviser.
Contributions. Many states offer tax benefits for contributions to a 529 plan. These benefits may include deducting contributions from state income tax or matching grants but may have various restrictions or requirements. In addition, savers may only be eligible for these benefits if you invest in a 529 plan sponsored by your state of residence.
Withdrawals. If you use 529 account withdrawals for qualified higher education expenses or tuition for elementary or secondary schools, earnings in the 529 account are not subject to federal income tax and, in many cases, state income tax. However, if 529 account withdrawals are not used for qualified higher education expenses or tuition for elementary or secondary schools, they will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings.
One of the benefits of 529 plans is the tax-free earnings that grow over a period of time. The longer your 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.
Does investing in a 529 plan impact financial aid eligibility?
While each educational institution may treat assets held in a 529 account differently, investing in a 529 plan will generally impact a student’s eligibility to receive need-based financial aid for college. You may also need to consider how having money in your 529 account for future qualified higher education expenses might affect financial aid for your student’s elementary or secondary school tuition. For many families, the larger part of a financial aid package may be in loans. So, the more you can save for school, the less debt you or your student may have to incur.
A 529 plan is designed to encourage early and consistent savings efforts by offering an easy, affordable and convenient way for families to save for college. While the tax advantages are one of the primary benefits, states also offer a variety of features and benefits to help families reach their college savings goals.
A great website for research is https://www.collegesavings.org
According to their website here are some 529 plan advantages and benefits.
- All withdrawals are exempt from federal income tax when used for qualified higher education expenses.
- All money grows free from federal and state income-tax.
- Many states also exempt withdrawals from state income-tax for qualified higher education expenses.
- The account holder retains control of the assets within the program regardless of beneficiary’s age.
- Most plans have very low minimum monthly contribution limits making them attractive to families regardless of income level. Some states have minimum limits as low as $15.
- The beneficiary can be changed at any time to another member of the beneficiary’s family (out to first cousins).
- Money can be used at virtually any accredited college in the country. You can find qualified schools on FAFSA’s website.
- Money can be used to pay for a variety of college expenses, including tuition, fees, room, board, books, supplies and required equipment.
- Contributions can be made conveniently through payroll deduction or automatic transfers from a bank account.
- Many plans offer maximum contribution limits of $300,000 or more.
- Assets within 529 plans are protected from bankruptcy.
- Most states offers a low cost plan that can be opened by contacting the plan directly.
- Many 529 plans are also offered through professional financial advisors who can help you choose a 529 plan and an investment strategy to meet your needs.
- Account owners can make a lump sum contribution of up to $75,000 per beneficiary or $150,000 if married filing jointly and avoid incurring a Gift Tax on this amount by electing to use five years of the annual gift tax exclusion all in one year. After utilizing this provision, the annual exclusion cannot be used again for the same beneficiary until the five year period has passed. Should a donor die within those five years, a pro-rata amount of the gift will revert back to their estate and be treated as a taxable gift.
- To better understand how 529 plans fit within the U.S. Department of Education Federal Financial Aid formula read: CSPN Report: Financial Aid Process Favors Saving for College May 2011
There are many great reasons and ways to save with a 529 Plan. If you would like to speak with us about your current 529 Plan or would like to start one email us at info@commonfinancialsense.com
