529 College Savings Plan
A 529 plan is a tax-advantaged savings plan for education costs, sponsored by a state agency or education institution. Learn how they are used and what their advantages are.
What Is a 529 Plan?
The formal name for a 529 plan is a “qualified tuition plan” (QTP), which are saving plans sponsored by states, state agencies, and educational institutions. They get their more common name from Section 529 of the Internal Revenue Code, which describes their tax advantages.
Types of 529 Plans
1. Prepaid Tuition Plans
Prepaid plans are state-sponsored accounts that allow the purchase of credits toward future college tuition at current prices.
The characteristics of prepaid tuition plans are as follows:
- They apply only to participating in-state public schools.
- There can be state residency requirements to participate.
- They are limited to tuition and do not include room and board.
- Plan benefits may be restricted for students who attend non-participating schools.
2. Education Savings Plans
Education savings plans are the more common type of 529 plan. These contain an account in which parents or other donors can save for a beneficiary’s future education expenses.
Characteristics of education savings plans include:
- Plans are sponsored by state agencies, but generally do not have residency requirements.
- Funds can be used at any college or university, including some outside the U.S.
- Funds can be used to pay up to $10,000 per year per beneficiary for tuition at an elementary or secondary school.
- Funds can be used for tuition, fees, and room and board.
- Investment options typically include mutual funds, exchange-traded fund portfolios, and a bank CD-type product.
All 50 states sponsor at least one type of 529 plan. In addition, some private colleges and universities sponsor their own prepaid tuition plans.
529 Tax Advantages
Tax advantages for 529 plans include a tax deferral on all income and gains inside the account and tax-free withdrawals if made for qualified education expenses. Most state plans will provide state tax benefits to match the federal benefits.
What 529 Funds Can Be Used For
Qualified withdrawals from a 529 plan may include:
- College or university tuition expenses
- Elementary and secondary education expenses
- Room & board
- Computer equipment and internet expenses
- Books and supplies
- Up to $10,000 toward student loan principal and interest of the beneficiary or a sibling
How 529 Plans Work
Plans can be set up through a licensed financial advisor or directly through the state. Most plans have low minimum monthly contribution requirements.
Tip: State-sponsored 529 plans will likely have fees associated with administration and investment. Purchasing a plan through an Advisor may have additional fees. Investors should check the offering circulars of plans they are considering to understand their fees.
Any US citizen can set up a 529 plan for a designated beneficiary. It is not necessary to reside in the state whose plan you select, though state tax benefits may only apply to residents in that state.
There are generally no annual contribution limits imposed by 529 plans, though some states may limit contributions to $250,000.
Contributions are, however, considered gifts and are therefore subject to gift tax exclusion limits for federal taxes (which is $16,000 per donor in 2022). Contributions above that amount must be reported on an IRS Form 709 and count toward the maximum lifetime exemption ($12.06 million in 2022).
The IRS also allows 5-year gift averaging for tax purposes that enables a contributor to deposit up to $80,000 upfront as long as no other contributions are made for five years.
Also, the states sometimes set aggregate limits for 529 plan contributions administered by that state for the same beneficiary over the life of the accounts.
Withdrawals for qualified education expenses are exempt from taxes on income and gains from the investments in the plan as long as they are for qualified education expenses.
529 Plans Per State
If not participating in a prepaid tuition plan within a specific state or for a specific school, a donor can set up a 529 plan in any state. Details for 529 plans, such as fees, investment choices, and tax benefits, however, can vary slightly by state.
Search for the most up-to-date plan details specific to your state on the Federal Reserve's website.
Advantages & Disadvantages of 529 Education Funds
- Tax deferral: All taxes on income and gains in the account are deferred.
- Tax-free withdrawal: No tax is levied on withdrawals if used for qualified education expenses.
- Transferrable: Plans can be transferred to another child in the family.
- Qualified education expenses: Plans can cover expenses for secondary education as well as college. Funds can also be used to pay for tuition, fees, room & board, books & supplies, computer equipment, and even to pay down student loans.
- Purchase flexibility: Can be purchased through financial advisors or directly through the state.
- Contributors: No income restrictions on contributors.
- Contributions: Low monthly minimums and can be made via payroll deduction. Many plans allow up to contributions of $250,000 or more.
- Investments: Must choose from limited available investment options.
- Specific state requirements: Some details may vary from state to state and will also be different for prepaid tuition plans.
- Taxes and penalties: Funds used for non-qualified education expenses are subject to taxes on income and gains plus a 10% penalty.
How To Start a 529
Three ways to start a 529 plan:
- Apply online through your state government
- Apply though your financial advisor
- Check out the College Savings Plan Network website for more information or to search and compare plans across the country
Yes. You can use 529 funds for room & board expenses and for books and other school supplies.
Possibly, yes. A 529 plan created by parents will be included in their assets for financial aid calculations, though only around 5.6% of total assets are considered. If someone outside the immediate family (such as a grandparent) funds a 529, it will generally not affect financial aid.
If your child doesn’t need all the funds in the 529 set up for them, you can change beneficiaries to another child in the family. Otherwise, the funds revert to the owner but will be subject to taxes on gains and possible penalties.
Yes, if invested in equity-related instruments. No, if saving through bank-offered instruments.
Here are several resources used for this article. They hold much additional information:
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.