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  • Writer's pictureRichard Williams

What Exactly Is a College Savings Plan 529?

Updated: Feb 2, 2022

A 529 account is a tax-advantaged financial instrument that can pay for eligible educational expenses for a designated beneficiary. College, K-12 education, apprenticeship programs, and student debt reduction can all be paid for using a 529 plan. Using a 529 method, your funds will significantly influence your financial assistance eligibility if you save for college.

college savings plan 529

The Michigan Education Trust (MET) developed the first education savings plan in 1986 when it established a prepaid tuition plan. A couple of years later, Section 529 of the Tax Code was created, allowing qualified tuition programs to be tax-free (also known as 529 plans). There are now over 100 different 529 plans available to meet a wide range of educational savings demands.

This article will go through the fundamentals of 529 plans, such as:

  • Tax Advantages of a 529 Plan

  • How to Select a 529 Plan

  • How Much Can I Offer?

  • Will a 529 Plan Influence Financial Aid?

  • What Is the Meaning of Qualified Education Expenses?

Tax Advantages of a 529 Plan

Your after-tax payments to a 529 savings plan are invested in mutual funds, ETFs, and other equivalent products, much as a Roth 401(k) or Roth IRA. Your donation grows tax-free and can be withdrawn tax-free if used to pay for qualifying higher education expenditures. Payments are not tax-deductible under federal law.

You may also be eligible for a state tax credit where you're from. More than 30 jurisdictions provide state income tax deductions and state tax credits for contributions to 529 plans.

Because donations are considered completed gifts to the beneficiary, some families utilize 529 plans as an estate planning tool. The yearly gift tax exception is worth up to $15,000 per donor and recipient.

college savings plan 529

How to Select a 529 Plan

Even though virtually every state seems to have at least one 529 plan, you aren't really limited to using the plan in your home state. Before you invest, consider your financial goals and your options. Each 529 program provides investment portfolios suited to the account holder's risk tolerance and time horizon. Your account's value may rise or fall depending on the success of the investment choice you choose.

How Much Can I Offer?

There are no annual contribution limitations to 529 plans; nevertheless, several essential factors to consider before making a big commitment. Donations over the yearly gift tax exemption ($15,000 in 2021) will be taxed from your estate and tax-exempt gift status ($11.7 million in 2021).

Each state also has a 529 plan aggregate contribution maximum that runs from $235,000 to $529,000. This figure is based on the cost of attending a high-priced college or graduate program, including textbooks and housing, and board.

As a general rule, you should attempt to save one-third of your projected future school costs. This implies that you can meet the remaining two-thirds of your expenses with current income, including scholarship funding and student loans.

college savings plan 529

What Occurs If I Can't Make My Monthly Installments?

Most plans enable you to set up regular recurring deposits from a connected bank account, although optional. After making a minimum first investment (sometimes as little as $25), you can invest as much as you want, whenever you want.

You may opt to make one-time contributions for special events such as birthdays, holidays, or other occasions. Gift contributions to 529 plans are also accepted by family, friends, and other loved ones.

Would a College Savings Plan 529 Have an Impact on Student Financial Assistance?

Whenever a dependent student or one of their guardians has a 529 plan account, the student's financial assistance eligibility is not as impacted except when they have a UGMA/UTMA account. The assets in a 529 plan are treated favorably on the Free Application for Federal Student Aid (FAFSA), and disbursements are not disclosed.

However, when a grandparent or other third party owns the account, it may significantly influence aid eligibility. Assets are not disclosed in this situation, but dividends used to pay for education are considered monetary assistance to the student. This can limit the student's eligibility for need-based aid by up to 50% of the distribution amount.

Qualified Education Expenses are what they sound like.

Keep in mind that only qualifying withdrawals are tax-free. That is, you should only utilize your 529 plan to fund eligible educational expenditures.

Tuition and fees, books and materials, housing and board (for students enrolled at least half-time), computers and related equipment, internet connection, and special needs equipment are qualifying college expenditures.

However, there are some expenses that you may feel are required but that the IRS does not consider to be eligible. Medical coverage and transportation fees, for illustration, are not qualified expenses unless the school bills them as part of the overall tuition price or the item is labeled as a fee that is "necessary for enrollment or attendance" at the college.

The IRS has recently broadened the definition of eligible education costs to include K-12 tuition and student loan repayments. The yearly maximum for qualified K-12 withdrawals is $10,000, while the lifetime cap on student loan repayments is $10,000.

A 529 plan's money is yours, and you can withdraw them at any moment for any reason. However, the earnings part of a non-qualified payout is subject to regular income taxes and a 10% tax penalty, with some exceptions.

college savings plan 529

Is it Possible to Utilize a College Savings Plan 529 to Pay for Rent?

Room and board are considered a qualifying expense if the student is enrolled at least half-time, which most colleges and universities define as six credit hours per term.

Qualified room and board expenditures for on-campus residents cannot exceed the amount paid by the institution for room and board. Eligible room and board expenditures for students living off-campus are restricted to the college's 'cost of attendance numbers. For additional information, contact your financial assistance office.

How to Make a Withdrawal from a College Savings Plan 529

You may use your education funds to pay for college at any qualified institution, including over 6,000 colleges and universities in the United States and over 400 overseas schools. For example, you might live in California, invest in a Vermont plan, and send your child to College in North Carolina.

Once you're ready to begin taking funds from a 529 plan, most allow users to direct payment to the payee, the recipient, or the institution. Some programs may permit you to transfer funds directly from your 529 accounts to a third party, such as a landlord. To learn more, see How to Pay Your Tuition Bill With a 529 Plan.

Remember to check with your personal plan to learn more about how to accept distributions. Based on your situation, you may be required to disclose payments to or disbursements from your 529 plan on your yearly tax filings.

college savings plan 529

What If My Child Doesn't Attend college?

The road is always unknown, and some parents are concerned about losing money invested in a 529 plan if their kid does not attend college or receive a scholarship. A few exemptions may apply to require you to pay income tax and a penalty on the earnings portion of a non-qualified transaction. The disadvantage is waived if and only if the following conditions are met:

The scholarship is tax-free for the recipient.

The recipient is a student at a United States Military Academy.

The recipient passes away or becomes handicapped.

The earnings part of the withdrawal, on the other hand, will be federal income tax and, in some situations, state income tax.

What happens to the money in a 529 plan that isn't used?

If you still have cash left in your account, 529 plan, and want to avoid paying taxes and penalties on your profits, you have a few alternatives.

  • Change the beneficiary to another qualified member of the family.

  • Keep the cash in the account in case the beneficiary decides to go to graduate school later.

  • Make yourself a benefactor and continue your studies.

  • Transfer the assets to a 529 ABLE account, a savings account designed particularly for persons with disabilities.

  • Since January 1, 2018, parents have been able to withdraw up to $10,000 in tax-free 529 funds for K-12 tuition.

  • Since January 1, 2019, qualifying dividends from a 529 plan can be used to repay up to $10,000 in student debts for both the recipient and the beneficiary's siblings.

Remember that you can withdraw funds from a 529 plan for any reason. However, unless you qualify for one of the exclusions stated above, the earnings component of a non-qualified transaction is taxed and penalized. If you are considering a non-qualified distribution, be aware of the requirements and various tax-saving strategies.

Plans for Prepaid Tuition

Another form of eligible tuition scheme is prepaid tuition programs. Prepaid enrollment plans enable you to pay in full for all or a portion of the costs of an in-state public college education. They can also be used in private and out-of-state universities.

Except Private College 529, a prepaid plan offered by more than 250 private institutions, most prepaid tuition programs are meant to save for an in-state public college. A prepaid tuition plan, although not a 529 college savings plan, can be offered by educational institutions.

How to Start a 529 Plan

It is simple to establish a college savings plan. A direct-sold 529 plan can be opened by completing an application on the plan's website. Direct-sold plans have lower costs than advisor-sold plans, but the account owner must choose the investments. 529 plans sold by certified financial advisors are the only ones accessible.

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