Paying for college tuition and other expenses is a challenge many students may face. There are many types of financial aid available, including grants, scholarships, Work-Study, and Federal Direct Loans. There is one additional way of saving for college that you may not be familiar with, called a 529 Plan (also known as a Qualified Tuition Plan). This is a special type of tax-advantaged savings plan that can help pay for many types of college expenses.
What is a 529 Plan?
A 529 plan is a tax-advantaged investment plan administered by a state or educational institution. Savings in a 529 plan are designated for use by a beneficiary for college expenses such as tuition, fees, and other college expenses. These plans are considered tax-advantaged because the gains are not federally taxed. Withdrawals used for qualifying expenses are also not subject to federal income tax. Many states have similar tax advantages for 529 plans, offering tax-free growth and tax-free withdrawals for qualified expenses.
Created in 1996, and formally known as Qualified Tuition Programs, 529 plans are named after section 529 of the Internal Revenue code. A 529 plan allows you to deposit money for a beneficiary to be used for college and other post-secondary training, or for tuition or enrollment in any private, public, or religious elementary or secondary school.
What Are the Advantages of a 529 Plan?
The main advantages of a 529 plan is the money is allowed to grow tax-free, as long as no money is withdrawn. Withdrawals for qualifying educational expenses are also tax-free at the federal level, and oftentimes at the state level too. Keep in mind, contributions to a 529 plan are not federally tax-deductible; however, some states offer state income tax deductions or credits.
Some of the qualifying expenses that are considered to be tax-exempt include: tuition, fees, books, and room and board at a qualifying college, university, or educational institution.
Anyone who wants to save money for college for a beneficiary can open a 529 plan account. The account owner is responsible for investment decisions and can change the beneficiary if they so choose. People can also gift money into a 529 account, allowing friends and family to contribute to the beneficiary’s education.
Another advantage of 529 plans is there is a low minimum contribution amount. Also, contributions in the 529 account are not considered to be part of the account owner’s estate.
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Who Can Open a 529 Plan?
Anyone who has the following qualifications can open a 529 plan account:
- US resident
- Aged 18 or above
- US mailing address
- Legal address
- Social Security Number or Tax ID
There is no income restriction or requirement for opening a 529 plan account, as the account owner, or as the beneficiary. You can also set up as many 529 plans as you want.
Beneficiaries of a 529 Plan
Anyone with a Social Security or Tax ID number can be a beneficiary of a 529 plan. There is no age limit or restriction on who can be a beneficiary. The beneficiary can even be the person who sets up the account.
The designated beneficiary of a 529 plan account is the student or future student for whom the account is set up. The student is not limited to the state in which their plan is based.
You can also change the beneficiary of the plan without tax penalty. You can also roll over funds from one plan to another for the same beneficiary or another member of the beneficiary’s family without tax penalty
What College Expenses Can a 529 Plan Pay For?
A 529 plan can be used to pay for tuition, fees, textbooks, learning materials, room and board, and computer equipment used for educational purposes, for any qualifying educational institution participating in student aid programs through the US Department of Education. This includes elementary and secondary schools, vocational schools, public, private, and religious schools (as of 2018).
Types of 529 Plans
There are two basic types of 529 plans: prepaid tuition plans and savings plans. Every state except for Wyoming offers one or both types of plans. The 529 plans in each state are unique. Educational institutions like a college or university can only offer a prepaid tuition 529 plan.
Prepaid Tuition Plans
A prepaid tuition plan allows participants to pre-purchase a future tuition at a predetermined rate in the present day. Participants purchase between one and four years of tuition at a locked-in rate for a beneficiary, and when that student is ready to go to college, the prepaid plan will pay out based on current tuition rates. These plans must be administered by the respective states or by a college or university. Only certain states offer prepaid tuition plans, most states currently only offer 529 savings plans.
Savings Plans
The most popular type of 529 plan is the savings plan, which must be administered by a state. Forty-nine states and the District of Columbia offer a savings 529 plan—only Wyoming does not. These plans offer many different options for investment, most often in mutual funds with different levels of risk and reward. Some 529 plans may offer bank deposit options that include FDIC or NCUA insurance, but investment options are generally subject to market risk and can lose value. The growth of the investments in a savings 529 are tax-free, and you can withdraw up to $10,000 per beneficiary per school year for K-12, and unlimited amounts for secondary education expenses such as tuition, required textbooks, and room and board. Colleges, universities, and most vocational schools are considered eligible for 529 funds.
Should you Go In-State or Out-of-State for Your 529 Plan?
Every state has different structures and incentives for their 529 plans. While you can invest in an out-of-state 529 plan, there may be advantages for using an in-state 529 plan. Some states offer state tax deductions or tax credits, matching grants, scholarship opportunities, and other benefits for using an in-state plan. Be sure to research the advantages and disadvantages of each plan you are considering. Most states allow you to use a 529 savings plan for qualifying expenses for any college, vocational school, elementary school, secondary school, or graduate school around the country.
Does a 529 Plan Have Contribution Limits?
Yes, there are practical contribution limits. Your contributions cannot exceed the qualifying educational expenses of the designated beneficiary. You may also be assessed gift tax on your tax return if your contributions exceed $19,000 per year.
Does a 529 Plan Have an Impact on Financial Aid?
The impact on financial aid eligibility and reward is relatively small, because 529 plans are considered assets of the account owner, not the beneficiary (student). Remember that the Student Aid Index (SAI) score is more generous to the parents of a dependent child than it is to the dependent student. The assets of the parents are scored differently, and it is more advantageous for your parents or grandparents to be the account owner of a 529 plan than yourself, if you are a student younger than 24 years old. When your parent is the 529 plan account owner, those plan assets are factored into the Student Aid Index (SAI).
Making Withdrawals From a 529 Plan
Withdrawals from a 529 plan can be made at any time, for any reason. Keep in mind, if the money is not used for qualifying educational expenses, there may be a 10% tax penalty on the withdrawal amount. State tax penalties may also apply on non-qualifying withdrawals.
As of 2018, qualifying withdrawals for educational expenses includes up to $10,000 per year for tuition for attendance or enrollment at any elementary or secondary school, that is a public, private, or religious school. According to the IRS, a computer or internet access used by the beneficiary while they are enrolled in an eligible school is also a qualifying educational expense.
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