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529 Plan Cheat Sheet

A common financial goal is to help pay for a child’s college tuition. Many families find 529 plans as a smart and tax-efficient way to finance future higher education expenses. These college savings plans were created by Congress under Section 529 of the Internal Revenue Service, from which they got their name.

Almost all states and the District of Columbia sponsor 529 plans that feature their own investment options and benefits. In most plans, you can contribute to a 529 plan in any state. However, since 529 plans vary, as do each individual’s circumstances, you should do your homework before choosing one. Here’s a simple 529 plan cheat sheet to help get you started:

Advantages of 529 plans:

  • Tax benefits such as tax-deferred growth and tax-free withdrawals, plus potential state tax deductions.
  • Limited restrictions on where your student enrolls or which state’s 529 plan you invest in.
  • Assets can be used for more than a four-year undergraduate degree. Expenses can also qualify for other educational institutions such as community colleges, graduate schools, trade or vocational schools and continuing adult education classes.
  • You have the flexibility to select from the range of investment options provided.
  • Your money can grow with the positive impact of compounding.

Disadvantages of 529 plans:

  • If you use the money for something other than educational expenses, you will be taxed a 10% penalty and may be subject to federal income taxes as well as state and local income taxes.
  • If your student doesn’t pursue college or there is money left over in the account, earnings may be subject to taxes and reimbursement limited to principal only in some plans.
  • Your investment options are limited to those offered in each respective state’s plan.
  • A 529 plan may impact a child’s ability to qualify for financial aid (although, it will likely have only a minor effect as it is considered an asset of the parents’, not the student).

Two types of 529 plans:

Prepaid plans

  • Allows you to pay for specific future academic periods or course credits at current tuition prices, but only for schools in the program.
  • You can lock in current tuition rates and do not have to worry about market returns.

Savings plans

  • Allows you to contribute to a student’s future college education expenses through an investment account.
  • Unlike in prepaid plans, you take on investment risks, but the earnings are generally not taxed and the funds can be used for any postsecondary institution.

Tax specifics:

  • Federal taxes: You do not pay federal taxes on earnings.
  • State taxes: Tax benefits differ from state to state. You may receive greater tax breaks in a plan offered by the state in which you are a resident.
  • Gift taxes: You can gift five years’ worth of savings in a single year, up to $70,000 (five times the annual $14,000 gift tax exclusion normally allowed), to each student without incurring gift taxes, as long as no further contributions are given to that student during the following four years.
  • Withdrawals: You may take withdrawals for postsecondary education expenses tax-free. Some 529 plans are exempt from state taxes, too. Nonqualified withdrawals are subject to a 10% penalty as well as federal income taxes and potentially state and local income taxes.

Eligibility:

  • Generally, anyone can participate in a 529 plan on behalf of any student. That means parents, grandparents, friends and relatives are eligible.
  • Typically, a student of any age can use a 529 plan, whether 1, 18 or 100 years of age.

Contributions:

  • Each state sets its own contribution limits, but the majority range from $200,000 to $300,000 and more.
  • Your account can still grow once you reach the limit, but you are unable to add contributions.

Costs and fees:

  • The fees and costs associated with 529 plans vary by state.
  • Investments offered in 529 plans have different expense ratios – lower expense ratios can mean greater savings.
  • Some 529 plans are sold with commission fees and/or enrollment and administrative fees.

Account owner control:

  • As a 529 plan owner, you are in charge of all assets and distributions.
  • A recent ruling allows you to change your investment options twice a year; however, you should think long term and avoid shifting investments based on short-term market trends.
  • You have the ability to transfer a 529 plan to any eligible family member of the student in the event that student chooses not to pursue a postsecondary education.

Tips for shopping for a 529 plan:

  • Find out what benefits you receive from your own state.
  • Compare costs and fees associated with each plan to help you save.
  • Understand the type of investment options available in each plan.
  • Look at the minimum investment amounts required to open an account. Some can be as low as $25.

A helpful way to choose a 529 plan is to use the comparison feature located on the College Savings Plans Network website.

Tips for investing in a 529 plan:

  • Contribute early and often. The sooner you start, the more your savings can benefit from compounding.
  • Keep costs low. Lower investment costs can let you keep more of your earnings working toward the student’s educational goals.
  • Invest for the long term. Frequently moving money among investments in your 529 plan can result in costly investment mistakes.