A 529 plan is a savings plan that is used to save money for college which offers certain benefits and some financial aid. 529 plans are quite versatile and they can be used for other things too, such as K-12 tuition bills.
The Types of 529 Plans
There are a couple of different types of 529 plans. The first type is a college savings plan and the second is a prepaid tuition plan. Most states have some sort of 529 plan available to their residents. You can also use a 529 plan provided via a conglomerate of universities and colleges.
If you like, you can invest in another state’s 529 plan other than your own. These plans can be used to pay for college tuition expenses at any qualified college across the country. Generally speaking, the college you select will not be affected by which state you had your 529 plan with.
If you live in Vermont for example, you could theoretically invest in a 529 plan from California or vice versa. If you lived in Vermont and used the California plan, as in the example described above, you could go to school in Florida, and that would be perfectly acceptable with the plan.
There are over 6000 U.S. colleges and universities and over 400 foreign educational institutions which work with 529 plans.
Most States Offer 529 Plans
The vast majority of states have some form of 529 plan available to their residents. Each state chooses whether or not to provide one or more 529 plans. Be sure to check out the benefits and features of your state’s 529 plan and compare them to other states with 529 plans you could invest in instead to see which 529 plan you would prefer to invest with.
Tax Benefits Of 529 Plans
Provided that your selected plan meets the requirements of the law, federal tax code provides certain tax benefits. One of those benefits is 5-year gift tax averaging and free qualified distributions.
Certain states provide tax incentives to investors in their state 529 plans as well. Each state will determine whether to provide one or more 529 plans to their citizens and what features and benefits it will provide.
The Two Types of 529 Plans
529 plans fall into two general categories:
Prepaid Tuition Plans allow you to pay some or all of the costs of a same-state public college education ahead of time. These plans can also be adapted for use at out of state or private colleges. The Private College 529 Plan is a different plan for private colleges that is sponsored by 250 different private educational institutions.
College Savings Plans work a lot like a Roth IRA or Roth 401(k). They invest your after-tax contributions in investment products like mutual funds or other investments. 529 plans come in many varieties that use different means to invest their funds, so you can choose a plan that fits your preferences. You can also keep track of the performance of the 529 plan you choose, and look at its historical performance over time to see how it compares to other similar plans that are available to you.
Specific educational institutions can provide a pre-paid tuition plan but not a college savings plan.
What can you use a 529 plan for?
529 plans are investment accounts that provide tax-free earnings growth and also tax-free withdrawals if the funds are used for qualified education expenses. You can use your 529 plan funds to pay for all applicable tuition and supply related expenses such as books, equipment, supplies, computers, and even things like room and board. You can also make withdrawals of up to $10,000 per year, tax-free, per person to pay for tuition at public, private, and religious K-12 schools.
What can’t you use a 529 plan for?
Technically, all of the money you put into a 529 plan is actually your money, so you can take it out at any time and for any purpose. However, if you do so, you’ll need to pay taxes and a 10% penalty on any non-qualified withdrawals. There are certain exceptions to this rule.
As a general rule, at the college or post-secondary levels, any expenses that are required to enroll in one of these eligible institutions will be covered. However, that doesn’t necessarily mean that every single cost that you think is necessary will be covered according to the IRS. Things like health insurance, transportation costs, and student loan payments are not qualified for example.
Can You Deduct 529 Plan Contributions On Your Tax Return?
Similar to with a Roth IRA, the contributions you make to a 529 plan are after tax and not deductible on your federal income taxes. However, about 30 different states do offer various state income tax deductions or credits for those who participate in 529 plans in their state.
How do you take advantage of a 529 plan?
When you are ready to use a 529 plan, you can generally distribute the funds to either the plan holder, the student, or the school. In certain cases your plan may also allow you to make payments to third parties such as a landlord for room and board. Be sure to check with your specific 529 plan to see what your distribution options are. You may also need to report any contributions or withdrawals to your 529 plan to the IRS on your annual tax returns.
What if I don’t use the 529 plan?
You never know what’s going to happen, and it’s common for people to worry about losing the money invested in a 529 plan if your child doesn’t decide to go to college or if they get a scholarship. Usually, you will need to pay income tax and a penalty percentage on the money you withdraw from a 529 plan for purposes other than education or other qualified expenses.
However, you can usually get this penalty wave if any of the following situations are true:
• Your plan beneficiary gets a tax free scholarship
• They die or become disabled
• The student attendance a US military Academy
Any earnings you make on the plan will generally be subject to federal and sometimes state income taxes.
What happens if my student doesn’t end up needing the money in a 529 plan?
There are a few options available if you need to take out the money for a purpose other than that which was originally intended:
• You could leave the funds in the account in case the student decides to go to college later
• You could change yourself to be the beneficiary on the account and go to college yourself
• You can roll the funds into a 529 ABLE account for people with disabilities
• You could also take up to $10,000 out for K-12 tuition
While 529 plans and tax law are both incredibly complex, we hope this article has helped to distill some popular questions about these useful savings tools for you and has answered some of your questions. Have you or a loved one use the 529 plan successfully to attend college? Feel free to share your experiences with us in the comments below!