December 15, 2020
What we’ll cover:
A 529 plan is a type of investment account with special tax advantages to help people save money to pay for certain education related expenses. These plans, sometimes referred to as “qualified tuition programs,” are typically administered by states.
There are two types of 529 plans:
Education Savings Plans. This is an investment account where you can put money away to help pay for qualified education expenses. The beneficiary of the account can be your kids, yourself or anyone else you’d like to help out. These 529 plans offer a variety of investment options; the details of these plans will vary state by state.
Prepaid Tuition Plans. These plans are less common. As the name implies, they allow you to pay the tuition for certain colleges or universities in advance. The idea of prepaying essentially allows you to lock in current tuition rates even though the beneficiary (i.e., the student) may not actually enter college for several years. Unlike education savings plans, prepaid tuition plans cannot be used to cover the costs of room and board. 529 prepaid plans can be sponsored by states or by participating higher education institutions.
Want to get a head start on saving for your kids’ school costs? Interested in helping out a family member? Or maybe you’re planning to return to school yourself one day?
Then a 529 savings plan could be right for you.
States, as well as the District of Columbia, administer their own 529 plans, so plan rules, features and contribution limits will vary state to state. When you’re ready to open an account, you can contact the specific state agency that’s in charge of the 529 plan you’re interested in. They will be able to provide the information you need to open a 529 account.
The College Savings Plans Network (CSPN), an affiliate of the National Association of State Treasurers, has a resource center for those interested in learning more about the specifics of each state’s 529 plan(s).
CSPN also provides direct links to plan websites and phone numbers to contact the plan sponsors.
No – you can invest in an out-of-state 529 plan. But it’s a good idea to look at your home state’s 529 program first. Some 529 plans offer state residents tax breaks and other benefits that might not be available to out-of-state residents.
Now let’s say you don’t like your state’s investment options, fees or other plan features . . . you’re allowed to shop around! Do some comparative shopping and find a 529 plan that best suits your needs.
Good to know: The CSPN website has a tool that allows you to compare plans by state and by features.
US residents who are over the age of 18 can open an account. You must be able to provide a U.S. mailing address and a Social Security number.
When you open an account, you can generally name anyone as the beneficiary. The 529 account could be for your child, other family members or anyone else you’d like to help out. He or she must be a US resident or citizen and have a Social Security Number.
Once you’ve opened a 529 account, you can start contributing to it. Generally, the money in the account can grow tax-free. When you’re ready to use your funds, you can withdraw the money tax-free, so long as it’s being used to cover qualified education expenses.
We mean things like K-12 education (up to $10,000 per year per beneficiary), college tuition, room and board, books, school supplies and computer equipment.
In December 2019, Congress expanded the category of qualified expenses with the passage of the SECURE Act. Under the act, 529 savings plans can now be used to pay for registered apprenticeships and student loan repayments of up to $10,000.
Yes, but the limit to how much you can contribute varies by state. For example, if you were to choose one of Oregon’s 529 plans, you’d have a maximum account balance limit of $400,000 per beneficiary. If you signed up for the Pennsylvania 529 plan, you could contribute up to $511,758 per beneficiary – what an odd amount . . . but you get the idea!
Remember, 529 plans are administered by states, so contribution rules and limits will vary. It’s a good idea to get the complete details directly from your state agency.
Ah, here’s where things get a little interesting. The answer depends on where you live and which state plan you have. Over 30 states and the District of Columbia offer a state income tax deduction or credit. Typically, to be eligible for the tax break, you need to be a resident of the state that sponsors your 529 plan.
Tax parity states. Now some states do offer a state income tax deduction to residents who make contributions to an out-of-state 529 plan. These include: Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania – you may hear them being referred to as “tax parity states.” Again, how much you can deduct varies by state.
There are eight states that don’t offer a tax deduction for residents who are saving in their 529 plans: California, Delaware, Hawaii, Kentucky, Massachusetts, Maine, New Jersey and North Carolina.
If you’re a resident of Indiana, Utah or Vermont and contribute to one of their plans, you can receive a state income tax credit (as opposed to a tax deduction).
Putting money into a 529 plan to help someone cover their education costs is a pretty thoughtful gift.
The IRS seems to think so, too. For tax purposes, 529 plan contributions are considered gifts, which means that the gift tax might apply to your contributions if they exceed a certain amount.
Let us explain.
Gifts are generally taxable. But the IRS does provide an annual gift tax exclusion – this is the amount a person can give to others tax free each year.
For 2020 and 2021, the annual gift tax exclusion is $15,000. Generally, this means that you can contribute up to $15,000 tax free to a family member’s 529 plan.
Of course, there’s a whole lot more to learn when it comes to 529 plans and taxes. Have you ever heard of the generation-skipping transfer tax or superfunding? But those are best discussed with a professional financial advisor.
We’ve covered the basics here and hope this article has helped to give you a better understanding of 529 plans.
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