529 Plans: Know the Basics
There are two kinds of 529 plans: prepaid tuition plans and savings plans. Prepaid tuition plans (available in only nine states) allow you to pay current tuition rates for future attendance at designated colleges and universities; they are a way to lock in a lower cost for college attendance. The savings plans allow you to save for education on a tax-deferred basis; additionally, withdrawals from the plan are tax free when they are used for qualifying education expenses.
Benefits of 529 savings plans
529 savings plans can be used to pay educational expenses from kindergarten through graduate school. Anyone can open a 529 account, but they’re typically established by parents or grandparents. They can be purchased directly from a state or from a broker or financial adviser. 529 savings plans offer investment portfolios tailored to the account owner’s risk tolerance and time horizon.
Rules and fees can differ by state. In some states, the person who opens the account may be eligible for a state tax deduction for contributions. Many states put a cap, ranging from $235,000 to $550,000, on total contributions. Some states may offer tax deductions on contributions. However, you’re not limited to using your home state’s plan.
Contributions to a 529 savings plan qualify for the annual gift tax exclusion ($18,000 for 2024).
Limitations of 529 savings plans
However, 529 savings plans come with some limitations. Most importantly, the funds must be used for education expenses like room and board, computers, special needs-accessibility equipment, books, and school supplies. The investment options are also limited. Some states have additional restrictions.
Fees for 529 savings plans vary depending on where you open the account. States often charge an annual maintenance fee, which ranges from $0 to $25. If you buy a plan from a broker or adviser, they may charge an additional fee. The investments and funds held by the 529 savings plan may also charge fees. (Low-cost mutual funds and ETFs will help keep management fees low.)
A 529 savings plan is a custodial account, so an adult controls the funds for a minor who can assume control when they turn 18 years old. Funds must still be used for qualifying educational expenses.
Impact on financial aid
Opening and contributing to a 529 savings plan potentially has minimal impact on financial aid, even though they are included in the expected family contribution calculated during the federal financial aid process. This is because 529 savings owned by parents are considered parental assets, which are factored into federal financial aid formulas at a maximum rate of about 5.6%, lower than the potential 20% rate assessed on student assets.
Unused funds
If you have money left over in a 529 account, you have several options:
- You can roll up to $35,000 into a Roth IRA account in the beneficiary’s name, provided the fund is at least 15 years old.
- You can change the beneficiary to another relative who qualifies according to transferability rules.
- You can keep the current beneficiary in case they want to go to graduate school.
- You can use up to $10,000 to pay off federal or private student loans for the original beneficiary or their siblings.
- You can cash out the account and pay the taxes and a 10% penalty.
The process of selecting the right plan, opening an account and contributing to a 529 savings plan is relatively straightforward, making the plan attractive for many families looking to secure an educational future for their children.
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