529s Explained
Welcome back! One of the most popular questions that parents and counselors ask is on how they can afford to pay for college.
For most, this is primarily focused on the financial aid and scholarships that they receive when they apply to colleges. But financial aid and scholarships may not pay the full cost of attendance. In that situation, families are left with some Expected Family Contribution (EFC), which turns into an out of pocket expense for the family.
One way that families prepare for the out of pocket expense is to use a 529. But what is a 529?
529 - Explained
A 529 plan is a tax-advantaged plan that can be used for a child’s educational expenses. Let’s break that out:
Tax-advantaged: the funds grow tax-deferred, meaning you don’t owe taxes on the growth and can use the funds to pay for qualified education expenses
Educational Expenses: these are qualified expenses for a child’s K-12, college, or post-grad studies (e.g., college tuition)
Let’s use an example:
You have a daughter, age 10
You open a 529 with $5,000 and put it in a target date fund
When your daughter is 18, the fund is now worth $10,000
For college, you owe $6,000 toward tuition as a part of your financial aid
You withdraw $6,000 from the 529 to pay the tuition you owe on your daughter’s behalf
You owe no taxes on this, and your 529 still has $4,000 for some future expense
Who can open a 529?
Generally speaking, anyone can open a 529 on behalf of a given beneficiary. That means a grandparent, parent, sibling, godparent, or even a friend could open a 529. The only thing that is required is that there is an account beneficiary (i.e., the child intended to receive the 529.
Are all 529s the same?
No, they are not. 529s largely differ in two ways:
Plan type
State regulations
Plan Types:
There are two types of 529s:
Education Savings Plan
Prepaid Tuition Plans
Education savings plans are what most think of when they consider a 529. In this plan:
Account holder contributes money to the account
The select a pre-selected investment option (usually a mutual fund)
May have a target date (as you get closer to the beneficiary going to college, the fund becomes more conservative to protect value)
Can be used for both college and K-12 expenses
A Prepaid Tuition Plan works differently. In that plan:
They are limited to a specific college or university
They allow you to lock in a “fixed” rate on tuition costs - you pay today’s costs for a future date of enrollment
These plans do not cover the cost of room and board, or any other expenses that may be included in the cost of attendance
There are usually restrictions on which colleges you can use them for, and they are not guaranteed by the government
What else do you need to know about a 529?
The basics have largely been covered, but there are some other key things to be aware of.
529s are transferable - meaning if you don’t use the full value on one child, you can transfer it to another child or other qualifying relative, which can even include a future grandchild
New laws also allow unused 529s to be rolled over into an Roth IRA beginning in 2024, assuming the 529s meet specific requirements
You can always use the 529 funds for non-qualified expenses - you will just owe taxes and a 10% penalty in that situation
There are usually not annual limits on how much you can contribute to a 529, but there may be lifetime limits
Note: Annual limits in excess of the federal gift tax threshold may incur taxes, but there are some special rules around this
529s are opened at a state level, and often qualify for special tax qualifications depending on the state they opened in
Conclusion:
Overall, 529s are a great savings tool and with recent changes in the law, the risks of opening a 529 have significantly declined. Remember:
Anyone can open a 529
529s can be used for K-12 and higher education - that gives more flexibility on how the funds get used and when
529s can be transferred - so if one child goes to college for free and you do not need the 529 for them, you can easily transfer it to another child, or save it for a future grandchild
Even if the 529 does not get used or you need access to the money, you can always pay taxes on the invested fund and the penalty to access it when you need to
You do not need a financial advisor to open a 529 - many banks offer the option to set one up online with little to no cost.
As with any investment, the sooner you open the account and begin saving, the greater the value through compounding and investment long-term.
Have questions about the 529? Feel free to mail us!