A 529 plan is a type of savings plan that is designed to encourage saving for future education expenses, such as college or vocational school. The plan is named after Section 529 of the Internal Revenue Code, which created these types of savings plans. Contributions to a 529 plan are typically made with after-tax dollars, but the money in the plan grows tax-free and can be withdrawn tax-free when used for qualified education expenses. Some states offer a state income tax deduction or credit for contributions to their own resident’s 529 plan. Each state operates its own 529 plan, but residents of any state can invest in any state’s plan.
A 529 plan is a special type of savings account that offers tax benefits for education expenses, ranging from kindergarten to graduate school. These plans come in two forms: educational savings plans and prepaid tuition plans. Each state, as well as the District of Columbia, sponsors and manages their own 529 plans, which may have unique rules and fees. One can either buy a 529 plan directly from the state or through a broker or financial advisor. It should be noted that as of Jan. 1, 2024, funds that are at least 15 years old and have a remaining balance of up to $35,000 can be transferred to a Roth IRA account.
2 Types of 529 Plans
There are two main types of 529 plans: educational savings plans and prepaid tuition plans.
- Educational savings plan: This type of 529 plan is similar to a 401(k) or an IRA. You contribute money to an account and the funds grow tax-free. The money can be withdrawn tax-free as long as it is used for qualified education expenses, such as tuition, fees, room and board, and books. The SECURE Act of 2019 expanded the types of expenses that can be withdrawn tax-free from a 529 plan to include expenses related to registered apprenticeship programs and up to $10,000 in student loan debt repayment for both the account beneficiary and their siblings. Additionally, as of January 1, 2024, the SECURE Act of 2022, which was passed as part of the 2023 Omnibus funding bill, will allow for the rollover of up to $35,000 of unused funds from a 529 account into a Roth IRA account. However, to be eligible for this rollover, the 529 accounts must be at least 15 years old.
- Prepaid tuition plan: This type of 529 plan allows you to purchase credits for future tuition at today’s prices. The credits can be used at in-state public colleges or certain private colleges. Some prepaid tuition plans are also transferable, which means that the credits can be used at any college or university, regardless of where the plan was purchased. While there is no annual limit on contributions to a 529 account, many states have set a maximum limit on the total amount that can be contributed. These limits vary and can range from $235,000 to more than $525,000. It’s important to be aware of the state’s maximum limit before making a contribution.
It’s important to note that each state has its own set of rules and regulations, and some plans may have different features or benefits. One should research and compare different plans before making a decision.
Benefits of 529 plans from a tax perspective
529 plans offer tax advantages for saving for education expenses. The key tax benefits include:
- Contributions to a 529 plan are typically made with after-tax dollars, but the money in the plan grows tax-free.
- Withdrawals from a 529 plan are tax-free as long as they are used for qualified education expenses, such as tuition, fees, room and board, and books.
- Some states offer a state income tax deduction or credit for contributions to their own resident’s 529 plan.
- The SECURE Act of 2019 expanded the types of expenses that can be withdrawn tax-free from a 529 plan to include expenses related to registered apprenticeship programs and up to $10,000 in student loan debt repayment for both the account beneficiary and their siblings.
- The SECURE Act of 2022, passed as part of the 2023 Omnibus funding bill, will allow for the rollover of up to $35,000 of unused funds from a 529 account into a Roth IRA account as of January 1, 2024 if the account is at least 15 years old.
It is important to check the rules of the state and the 529 plan before investing, as the tax benefits of a 529 plan may vary depending on your state of residence and the plan you choose.
Advantages and Disadvantages of 529 Plans:
| Advantages | Disadvantages |
|---|---|
| High contribution limit | Limited investment options |
| Flexible plan location | Different fee levels per state |
| Easy to open and maintain | Fees can vary; restriction on changing plans |
| Tax-deferred growth | Restriction on switching investments |
| Tax-free withdrawals | Must be used for education |
| Tax-deductible contributions | Depends on state; restrictions apply |
529 Plan Transferability Rules
529 plans are governed by the federal tax code, specifically Section 529, which includes transferability rules. According to these rules, the account owner (typically the person who opened the account) is allowed to transfer the account to another 529 plan once per year, unless a change in the account beneficiary is involved. In that case, there is no limit on how many times the account can be transferred. Additionally, it is possible to change the beneficiary without changing the plan.
The individuals who can be listed as beneficiaries of a 529 plan include:
- A son, daughter, stepchild, foster child, adopted child, or descendant of any of them
- A brother, sister, stepbrother, or stepsister
- A father or mother or ancestor of either
- A stepfather or stepmother
- A son or daughter of a brother or sister
- A brother or sister of father or mother
- A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
- The spouse of any individual listed above
- A first cousin
It’s worth noting that you are not restricted to investing in your own state’s 529 plan, but doing so may provide a tax break. It is recommended to check the plan of your state before investing.
529 Plan FAQs
“529 Plans: How to Open, Costs, Control, and Qualified Expenses”
Opening a 529 Plan: 529 plans can be established directly with a state or through a broker or financial advisor. They can help you to choose from a variety of plans that are available in different states.
Costs of a 529 Plan: States generally charge a one-time account setup fee, which can vary from as low as $25 to as high as $964. Additionally, if you purchase a plan through a broker or advisor, they may charge an additional fee, usually up to 5% or more, on the assets under management. The investments and funds inside of your 529 plan may also have ongoing fees. To minimize these fees, consider looking for low-cost mutual funds and ETFs.
Control Over a 529 Plan: A 529 plan is considered a custodial account, which means that an adult custodian controls the funds on behalf of a minor. Once the beneficiary reaches the age of 18, they can assume control over the 529 plan, but the funds must still be used for qualified education expenses.
Qualified Expenses for a 529 Plan: The expenses that are qualified for a 529 plan include tuition and fees for college, graduate, or vocational school, elementary or secondary school (K-12) tuition and fees, books and school supplies, student loan payments, off-campus housing, campus food and meal plans, computers, internet, and software used for schoolwork (student attendance required), special needs and accessibility equipment for students.
A 529 plan is a tax-advantaged way to save for education expenses from kindergarten to graduate school, including apprenticeship programs. With the SECURE Act of 2022, there is now an option to transfer up to $35,000 of unspent funds into a Roth IRA account if the 529 account is 15 or more years old .
