Understanding 529 Plans: An Essential Guide for Parents and Students
Melissa A. Seamon, CFP®
Senior Financial Advisor
We all dream of offering our children the best possible education, but it often comes with a considerable cost—college tuition. Don’t let the mounting dollar figures make you anxious because we have good news: it’s called a 529 plan, and it can make saving for higher education more manageable.” Whether you're already a parent or planning for future children, understanding and leveraging a 529 Plan will help with college savings.
We understand that many prospective and current parents have numerous queries about 529 Plans: What are they exactly? Who can use them? Are they suitable for me? Can they help alleviate the immense burden of higher education costs? In this comprehensive guide, we will unravel the basics, dispel common misconceptions, and answer your most pressing questions about this financial tool.
Here are Eight Considerations:
1. What is a 529 Plan and How Does it Work?
A 529 Plan, named after Section 529 of the Internal Revenue Code, is a tax-advantaged savings plan designed to encourage saving for future education costs. A 529 Plan is where you can safeguard your hard-earned money, let it grow over time, and when it's time for college or vocational school, utilize the funds to cover the expenses, all while enjoying significant tax benefits.
There are two primary types of 529 Plans: the prepaid tuition plans and the education savings plans.
- Prepaid Tuition Plans: These plans let you secure current tuition rates for in-state public colleges, which can be beneficial if tuition fees skyrocket in the future, which they often do. In some instances, these plans can also be converted for use at private or out-of-state colleges. However, they typically do not cover room and board and have limited enrollment periods.
- Education Savings Plans: These plans conversely, can be used to cover tuition, room and board, compulsory fees, and even specific equipment and supplies required for college or vocational school. They offer more flexibility, allowing you to invest your after-tax contributions in a variety of investment options provided by the plan, and use your earnings tax-free for eligible education expenses at any approved school nationwide or even some overseas.
In a 529 Plan, you—as the account holder—retain control of the funds, irrespective of the beneficiary's age. This means you dictate when withdrawals are made and for what purpose. Furthermore, if your original beneficiary decides not to attend college or secures a full scholarship (congratulations to them!), you can effortlessly switch the beneficiary to another family member, including yourself if you wish to pursue further education.
The bottom line? A 529 Plan is a savings tool that allows your money to grow tax-free, while providing flexibility and control over the funds
Each type has its merits and should be considered based on your individual circumstances and risk tolerance.
2.Who Can Own a 529?
Absolutely anyone. There is no restriction on who can own a 529 plan and select any beneficiary. We often encounter the misconception that a 529 Plan is exclusively for parents with children. Thankfully, that's not the case.
Anyone—parents, grandparents, aunts, uncles, friends, or even prospective students themselves—can open a 529 Plan. You can be single or married, young or old, with or without children. There's no income restriction, and you're never too young or too old to start or contribute to one. In other words, if you're contemplating helping someone—or even yourself—with future educational expenses, you're on the right track.
This means, even if you're single with no children, you can open a 529 Plan for your future child or for yourself. If you're considering returning to school in the future or pursuing a postgraduate degree, this plan can be a strategic move.
As the account owner, you can name anyone as a beneficiary—even yourself. The beneficiary doesn't have to be a relative. However, if you want to change the beneficiary later without incurring taxes or penalties, the new beneficiary must be a family member as per the IRS definition, which includes spouses, siblings, children, nieces, nephews, cousins, and even in-laws.
Additionally, you're not restricted to your own state's 529 Plan. You can research and choose any state's plan that suits you. Some states do offer state income tax deductions or credits for contributions, so considering your own state's plan might be beneficial, but it's not mandatory. You should compare investment options, fees, and state tax benefits when choosing a plan.
So, if you've been wondering whether you need to have a child before you can start a 529 Plan, rest assured. Anyone with foresight for the future can start saving for education costs with a 529 Plan. It's truly a tool designed for all!
3. What Happens to a 529 Plan if a Scholarship is Awarded?
Yes, your 529 plan can coexist with a scholarship. Most scholarships cover only a fraction of the tuition, and a 529 plan can supplement the rest. In case of a full scholarship, you can modify the 529 plan to another family member beneficiary. Acceptable beneficiary changes include:
● First cousin
● Sibling
● Stepsibling
● Another child
● Parent
● In-law
● Grandparent
● Grandchild
● Aunt
● Uncle
One stipulation concerning 529 distribution with a scholarship is that the amount you withdraw from your 529 plan cannot exceed the scholarship amount each calendar year.
4. Can I Combine a 529 Plan with Financial Aid?
A 529 plan is regarded as an asset of the parent or guardian of the student beneficiary. While financial aid is still a viable option alongside a 529, it will be reduced by 5.64%. If your 529 plan has $25,000 for use, financial aid would be trimmed by $1,400. The impact on financial aid depends on the holder of the 529 plan. If grandparents open a 529 plan for a grandchild, different rules apply. The 529 contribution isn’t counted on your Federal Student Aid Form (FAFSA). It is counted as untaxed income instead, resulting in less aid in the subsequent year.
5. Do I Have to Use a 529 Plan Offered in My State?
No. While 529 plans are state sponsored, you are free to select any plan from any state. Investing in your own state’s plan can have benefits, as some states offer a state tax deduction to residents. However, each plan should be carefully examined. Even with a potential tax deduction, some plans may be more beneficial than others. Your 529 plan can also be used at eligible schools throughout the United States, not just in your home state. Furthermore, many foreign universities also accept funds from 529 plans. This makes a 529 plan a flexible tool for funding education, no matter where your child, or you, decide to study.
6. How Can I Use the Money in a 529 Plan?
The money you save in a 529 plan is intended for qualified education expenses, which include:
- Tuition and fees
- Room and board, if the student is enrolled at least half-time
- Books, supplies, and equipment necessary for study
- Expenses for special needs students
- Up to $10,000 in student loan repayments, including both principal and interest
- Certain apprenticeship program costs
If you withdraw money for anything other than these qualified expenses, the earnings portion of the withdrawal will be subject to federal income tax and typically a 10% penalty.
7. Is There a Limit on How Much I Can Contribute to a 529 Plan?
While there's no federal limit on contributions to 529 plans, each plan has a limit based on the total amount necessary to provide education to the beneficiary. Once this limit (which varies by state but can be up to $500,000) is reached, no more contributions can be made. However, the account can continue to grow through investment returns.
Furthermore, while contributions to a 529 plan aren't deductible on your federal tax return, they might be deductible on your state tax return, depending on where you live. And, as we mentioned earlier, withdrawals for qualified education expenses are tax-free at both the federal and state level.
8. What Happens If My Child Does Not Go to College?
If the beneficiary decides not to attend college, there are several options available:
- Change the beneficiary to another family member who plans to attend college. The IRS has a broad definition of "family member" which includes siblings, first cousins, in-laws, and even yourself if you're considering further education.
- Hold onto the account in case the beneficiary decides to attend college later. There's no age limit on when 529 plan funds need to be used.
- Withdraw the money for non-educational purposes. The earnings portion of the withdrawal will be subject to income tax and a 10% penalty.
A 529 plan is a versatile tool that offers many benefits to families planning for higher education expenses. By starting early and contributing regularly, you can take advantage of tax-free growth and potentially save a significant amount for your child's future education. Be sure to consult a financial advisor to discuss your personal circumstances and ensure you make the most of this powerful savings tool.
Need help deciding how to fund your child or grandchild’s education?
The team at Gardey Financial Advisors is here to help.
Simply schedule a call with one of our advisors today to learn about our comprehensive financial planning and wealth management services. We best serve clients looking for exceptional client service, who value a long-term partnership, and have a minimum of $500,000 in investable assets.
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Resources:
https://studentaid.gov/h/apply-for-aid/fafsa
https://finaid.org/savings/state529deductions/
https://www.sec.gov/about/reports-publications/investor-publications/introduction-529-plans