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Which 529 plan is right for your family? One is a prepaid tuition plan and the other works more like an investment account. Learn about the differences and the advantages of establishing a 529 plan. May is a good time to review education savings to ensure your family is on track.
529 plans generally come in two forms. The first – prepaid tuition programs – which allows participants to lock in tuition rates at eligible state colleges or universities with a lump-sum investment or monthly installment payments. Because prepaid tuition programs are governed by individual state rules, availability and transferability can vary, so review plan details carefully.
The second – college savings programs – allows contributions to vary. The full value of the account can be applied at any accredited institution of higher education nationwide. Since 529 plans operate under individual state laws, costs and details vary by state. In many cases, college savings plans may also be used for certain other qualified education expenses, which can make them more versatile than some people realize.
Substantial Contributions Allowed
Although, contribution limits vary by state, some plans allow total account balances of $500,000 or more per beneficiary (with no income limitations or age restrictions), compared to $2,000 annually per beneficiary for a Coverdell Education Savings Account (formerly known as an education IRA). Because plan limits are set at the state level, parents should confirm the current limit for the specific plan they are considering. In general, 529 plans offer significantly more room for long-term education savings than many other education-specific accounts.
Tax Benefits
Although contributions are not deductible, earnings in a 529 plan grow tax-free at the federal level and are also not taxed at the federal level when money is taken out to pay for college. Many states also offer state tax deductions, credits, or other benefits for residents who use their home state’s plan.
In addition, there may be other benefits. For example, qualified uses may extend beyond college tuition alone, depending on the expense and the plan rules. Current federal rules allow for some 529 withdrawals for K-12 tuition, certain registered apprenticeship expenses, and allowances for student-loan repayment (with limitations per individual and subject to applicable requirements).
Often, the 529 account must be open for at least 12 months before any money can be withdrawn. Rather than assuming a universal timing rule applies, it is wise to review the specific plan’s distribution procedures and eligible-expense requirements before taking withdrawals.
Special Estate Planning Features
A 529 plan may also provide estate-planning benefits. Current IRS rules allow annual gifts up to the federal exclusion amount per beneficiary. Another unique feature of 529 Plans is that a donor can make a lump-sum contribution to a 529 plan of up to five times the annual gift tax exclusion and completely avoid federal gift tax, provided the donor makes no other gifts to the same beneficiary during the five-year period.
Other Considerations
Professional Management. 529 plans offer a “hands-off” savings approach, since funds invested in the plan are professionally managed. Depending on the plan, parents may be able to choose from age-based portfolios or other investment options that align with the time horizon and risk tolerance.
Beneficiary Change. If the original beneficiary’s plans change, the account owner may be able to change the beneficiary to another eligible family member. Current law also allows certain 529-to-Roth IRA rollovers for the beneficiary, subject to several conditions, check with your financial professional for details.
Financial Aid Impact. Any investment may affect a student’s eligibility for financial aid. Earnings withdrawn from a 529 plan are treated as income to the child and will show up on the following year’s financial aid application. It might make sense to reserve 529 funds for use in a student’s later years. The financial-aid impact of a 529 plan depends in part on account ownership and the aid methodology being used. Because financial-aid rules have evolved, families should review current FAFSA and school-specific considerations to understand how a 529 plan will affect eligibility.
It’s Worth a Look
Keep in mind, there is no guarantee that any investment portfolio will achieve its investment goals. As with any investment-based account, the value of a 529 plan will fluctuate, and parents should compare fees, investment options, state tax treatment, and withdrawal flexibility before selecting a plan.
For more complete information on 529 plans, contact your financial professional. For families looking to save with greater intention, National 529 Day can be a useful prompt to revisit their education funding strategy and determine whether a 529 plan fits within their broader financial plan.
