Reduce taxes by using a 529 plan for education savings.
In this episode I’ll discuss 529 plans and the many benefits they provide to millions of Americans who use them.
What’s a 529 Plan?
A 529 plan is also known as a Qualified Tuition Program. It’s a tax-favored savings account that has become the most popular way to save for higher education. The idea is that you contribute money to the plan that can be used to pay for a student’s qualified expenses at a specific, eligible school. A 529 plan can be opened for any adult or child in your family or even outside of your family.
Types of 529 Plans
529s are generally categorized as either prepaid plans or savings plans. With pre-paid plans you can pre-pay all or a portion of the cost. If the student decides to attend a different eligible school, the funds can be still be used for qualified expenses. However, depending on which plan you have, there may be a penalty for this transfer of funds.
529 savings plans, on the other hand, are similar to a retirement account where your contributions are invested in chosen mutual funds or securities. The account value will fluctuate based on the performance of the underlying investments.
Who Operates 529s?
Either type of 529 plan can be set up by states as well as by eligible institutions. These include colleges, universities, vocational schools, or other postsecondary schools that participate in federal student aid. The school you’re interested in can tell you if they if they’re eligible to accept 529 funds and if they operate their own plan. But if they don’t operate one, don’t worry, every state now has at least one 529 plan in which you can participate.
Enrollment in a 529 can be done directly with the plan manager or through an independent stock broker or financial advisor. Understand that each plan has different features and benefits, so it’s important to do some research before enrolling in one. I'll include a link in the show notes at the bottom of this page to a handy 529 plan comparison tool as well as to a lookup tool for 529 eligible schools.
How 529s Work
Many people believe that if they contribute to a state 529 plan that the student must attend a school in that state. In most plans you can choose any school no matter where you live or what state or institution manages the plan! You could live in California, invest in a Florida plan, but send a student to a North Carolina college. So don’t fall for the misconception that a state-sponsored 529 plan is only for those who want to send a student to a state school.
529s offer some nice savings because contributions and earnings grow tax free. Funds in a 529 are taxed only if withdrawals from the account exceed the total amount of qualified education expenses. You may be able to receive some additional tax advantages if you invest in a plan sponsored by your home state.
Another reason 529s are so popular is because they offer flexibility. You can roll over funds from one plan to another within 60 days without incurring a penalty. And the student, or designated beneficiary, can always be changed to another member of the beneficiary’s family. So if the child you’re saving for decides to become the next world-champion poker player, instead of going to college, no worries!
Who Can Contribute & How Much
There are no income or age restrictions placed on contributors or students. Everyone is eligible to take advantage of a 529 plan. The maximum amount you can contribute actually varies from plan to plan, but it’s over $300,000 per student in many state plans.
There’s no annual limit to how much you can contribute. However, as I mentioned, contributions can’t exceed the amount of educational expenses that the student will need. If you’re not sure how to calculate this amount, contact the eligible school for a total estimate of qualified costs for the student.
What Expenses are Qualified
Qualified expenses that can be paid with 529 savings include tuition, fees, books, and all required equipment and supplies for coursework. Reasonable costs for room and board also qualify for those who are at least half-time students.
Excess Plan Funds
Here’s a tip for dealing with excess funds in a 529 plan: if the beneficiary has a family member who’s a potential student, change the designated beneficiary on the account to his or her name instead of closing the account. This will help you avoid or perhaps delay having to pay taxes on a non-qualified withdrawal. See IRS Publication 970 for a list of relatives who qualify as members of the beneficiary’s family for this purpose.
If you want to save for the education of a child or other family member, I encourage you to open a 529 plan. Or perhaps you’re considering going back to school for an M.B.A., to become a pilot, or for cooking classes. As long as the school you’ll attend is eligible to accept 529 funds, you’ll benefit from setting up and contributing to a 529 plan for yourself.
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Chi-Ching, that's all for now, courtesy of Money Girl, your guide to a richer life.
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