A 529 College Savings Plan is a plan operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild.
529 College Savings Plans are investment vehicles designed to help families pay for future expenses associated with college or other qualified post-secondary training. Though contributions to a 529 plan are not deductible, these plans offer other tax advantages and are named after Section 529 of the Internal Revenue Code.
As noted by SEC.gov, 529 plans are also known as “qualified tuition plans.” States, state agencies, or educational institutions sponsor these plans, and all 50 states and the District of Columbia sponsor at least one type of 529 plan.
Some of the top benefits of 529 plans, as noted in SavingForCollege.com, are as follows:
- 529 plans offer unsurpassed income tax breaks.
- Although contributions are not deductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college.
- This has been a huge incentive for Americans to save for college. The tax treatment was made permanent with the Pension Protection Act of 2006.
- You can generally claim state tax benefits each time you contribute to your plan, so it’s a smart idea to continue keep making deposits until you’ve paid your last tuition bill.
- You, the donor, stay in control of the account.
- With few exceptions, the named beneficiary has no legal rights to the funds so you can assure the money will be used for its intended purpose.
- A 529 account owner can withdraw funds at any time for any reason — but keep in mind that the earnings portion of nonqualified withdrawals will incur income tax and an additional 10% penalty tax.
- Low maintenance
- The ongoing investment management of the account is handled by an outside investment company hired as the program manager or by the state treasurer’s office.
- Simplified tax reporting
- Contributions to a 529 plan do not have to be reported on your federal tax return.
- You won’t receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals.
- Deposits to a 529 plan up to $14,000 per individual per year ($28,000 for married couples filing jointly) will qualify for the annual gift tax exclusion.
- You can change your 529 plan investment options twice per calendar year.
- You can rollover your funds into another 529 plan one time in a 12-month period.
- Everyone is eligible to take advantage of a 529 plan.
- Unlike Roth IRAs and Coverdell Education Savings Accounts, 529 plans have no income limits, age limits or annual contribution limits.
- There are lifetime contribution limits, which vary by plan, ranging from $235,000 – $400,000.
A Need for Greater Awareness about 529 Plans
In a recent May 2016 article from The Washington Post, the writer observed a need for greater awareness about 529 plans. In fact, as the Post notes, 72 percent of Americans do no know what a 529 plan is. And when people do know about it, there are misconceptions. One common misconception is the belief that a child can only go to schools in the state where the parent holds the 529 account. The truth is that any money invested in a 529 is available to use at any public or private school in the nation. In fact, the 529 can even be used in many schools around the world.
The Effect of 529 Plans on Financial Aid
As is the case with any source of funding that you use to pay for a student’s college education, you should always double-check with the financial aid office of your child’s institution. As noted in a recent May 2016 Forbes article, the 529 can have an effect on a student’s financial aid package. Generally speaking, on the FAFSA form (the form used by students to apply for financial aid at colleges), a 529 plan owned by the custodial parent(s) counts as an investment when the financial aid office assesses what resources a family has to pay for college. As an investment, the 529 plan may reduce need-based aid, but—and this is the good news—it cannot be more than 5.64% of the asset’s value, according to FAFSA regulations. In many cases, however, depending on the family’s income situation, the 529 plan has minimal or no impact on a student’s financial aid package.
In addition, even when parents choose to withdrawal from the 529, it has minimal impact compared to other assets, as noted by Forbes:
Withdrawals from 529 plans used for qualified higher education expenses owned by the custodial parent are not typically reported as parent or student income. Since only a small amount of the 529 plan is counted and none of the withdrawals, custodial parent-owned 529 plans generally have the least impact on your child’s financial aid package. Typically, parents are one of the owners whose 529 plans get the most favorable treatments, so ideally the custodial parent should own the 529 plan.
If the 529 plan is not taken out in the name of the parent, but a relative, say a grandparent, the plan will not be counted as an asset on the FAFSA. However, other withdrawal rules apply in these situations (i.e. the withdrawal from the grandparent’s 529 plan counts as non-taxable student income). For a comprehensive list of these rules, you can refer to this article to get an idea of how it works. But by far the most critical thing to do is to consult your school’s financial aid office. While schools follow federal guidelines, there can also be many institution-specific policies that affect the situation for a student. In other words, never make any major financial aid-related decision without first consulting your child’s assigned financial aid officer. If your child is not enrolled in any specific college yet, financial aid offices often meet with the parents of prospective students (i.e. students who are interested in applying to their school), and it is always wise to schedule financial aid appointments at any of the schools that your child is interested in attending. Call ahead to set these appointments up when you go to visit the campus or attend admissions-related events during the school selection process.