529 College Savings Plan

A financial account that allows you to save and invest money for the purpose of paying for education expenses, from K-12 to college and trade schools.

529 plans have two types, one that lets you invest money without paying taxes on your investment’s profits, and another that protects you from rising college prices by letting you prepay college tuition at today’s prices.

529 college savings

What is a 529 plan?

A 529 plan is a financial account designed to help families save for college, trade schools, and K-12expenses.

There are two types of 529 accounts- 529 Education Savings Plans and Prepaid Tuition Plans. The first is a tax-advantaged investment account and the second is a program that lets you pre-purchase college credits at today’s prices.

The program is named after the Internal Revenue Code’s Section 529

529 programs are established and maintained by a State, an agency, or an educational institution. Under these programs, a person can contribute cash to an account that will later be used to cover education costs for a beneficiary.

In other words, you can open a 529 account and set your child, or another child in your life, as the beneficiary, with the goal of paying down the child’s (often high) education.

529 accounts are offered by states, brokerages, and some colleges and universities.

Some 529 plans are limited to residents of certain States, but many 529 plans are open for enrollment nationally.


What is a 529 Education Savings Plan?

The 529 Education Savings Plan is an investment account that lets you invest money in the market and provides tax benefits on the profit you make from your investments.

These programs are established for the purpose of paying for future education expenses, like tuition, room & board, and other qualified expenses (more below).

You can use up to $10,000 per year to pay for K-12 tuition per child.

When you invest through this529 account, you can choose to invest in a wide range of investments, including mutual funds, ETFs, or simple savings accounts that keep your money’s value(but don’t grow much).

Many 529 programs offer managed portfolios that you can choose from that already mix different investment options, eliminating the need to actively manage your investment.

This makes 529 college accounts great for people who prefer a hands-off approach to growing their investments.

On top of that, many 529funds offer age-based portfolio or target-date portfolios. Similarly to retirement accounts, age-based portfolios automatically adjust investments to lower risk of losing money as the beneficiary reaches college age.

Investments in these accounts may lose value when their inherent holdings lose value, same as any other investment account.

There are two main advantages to saving for higher education with this account type. First, the tax benefits can be substantial over the course of 18 years (or even less).

Secondly, the psychology of money tells us that earmarking money towards a specific goal is often a strong enough driver to achieving that goal, and these accounts are clearly designed to afford higher education.

What is a Prepaid Tuition Plan?

The Prepaid Tuition Plan is the less popular type of the 529 plan and offers you the option to pre-purchase college credits and tuition for your child, at today’s prices.

This type of 529 plan is offered directly by some colleges.

One of the major disadvantages is that by buying a credit at a school when a child is young, you limit that child to only going to that school.

What are the 529 plan tax benefits?

The 529 Education Savings Plan lets you invest after-tax dollars and provides tax benefits on the profit you make from your investments.

If used to pay for a qualified expense, the investment dollars won’t count towards your gross income when you use the money, meaning you won’t need to pay capital gains taxes on your profits.

Capital gains taxes are the taxes that you pay on the profit part of investments that you hold for at least one year and count toward your income taxes.

Currently, if your taxable income is over $40,400 for single ($80,800 for married filing jointly) your capital gains tax rate is 15%.

If you save and invest $200monthly for your child from birth to 18, you contribute a total of $43,200. Assuming an average return rate of 8%, your contributions could grow by an additional $52,817for a total of $96,017.

Your tax savings would be 15%of the $52,817 profit, or a total of $7,922 that you would owe in taxes if you invested in a regular investment account.


What are 529 eligible expenses?

In order to enjoy the tax benefits from a 529 Education Savings Plan, you can only spend your 529 funds on an expense that is pre approved by Internal Revenue Code Section 529.

529 Plan eligible expenses include K-12 tuition, college expenses and qualified apprenticeship programs that are registered and certified with the Secretary of Labor.

A student may also pay backup to $10,000 per year of student loans from a 529 account.

This is the full list of qualified529 expenses:

For Private, Public or Religious Elementary and Secondary Schools:

  • Tuition (limited to $10,000 per year per child)

For College or ApprenticeshipPrograms:

  • Tuition
  • Room & Board
  • Fees
  • Books
  • Supplies
  • Equipment
  • Expenses for special needs services in connection to school enrollment or attendance
  • Computer and peripheral equipment
  • Internet access and educational software

What are the 529 account penalties?

If you withdraw the money saved up in your 529 account and use it for anything other than qualified education expenses, the investment profit will count towards your income taxes plus an additional 10% federal tax penalty on the profit part of the funds.

If for example over the years you managed to contribute $15,000, and that investment grew by an additional $7,500for a total of $22,500 in your 529 account, you would only need to pay the penalty on 10% of the $7,500, or $750.

You would also need to pay taxes on the additional the $7,500 additional income.

But keep in mind that paying taxes means you’ve made a profit, and even after 15% capital gains and 10%penalty you still would make more than $5,000 in this scenario!

How do I open a 529account?

Opening a 529 online is easy and can take as little as 10 minutes.

You can choose to open an account through an advisor or broker, or you can set one up yourself with a Direct529 Plan.

A Direct 529 Plan lets you choose an investment portfolio on your own from a number of managed portfolio.

Each 529 plan sets its own account fees and management fees, so pay attention to the details.

Factors to consider when choosing a 529 plan

  • State tax benefits and incentives (look at your state's plans first!)
  • The percentage fees of the total invested assets
  • Other plan fees, like an annual fee or opening fee
  • Investment options available with the plan

What happens to a 529 if your child doesn’t go to college?

You have a few options if your child doesn’t end up going to college.

You can withdraw the money from the account and simply pay the income taxes and the penalty on the profit side of the account.

If you have anyone else in the family that could benefit from the 529, you can change the plan’s designated beneficiary. 529 plans allow changing the beneficiary to any family member of the original beneficiary.

Can I change the beneficiary of a 529 account?

You can change a 529 account’s beneficiary to any family member of the original beneficiary, without needing to move the account itself to another program.

What are the contribution limits for a 529 plan?

While there are no yearly limits on contributions to a 529 plan, every contribution qualifies as a monetary gift, and as such is treated under the gift tax law.

There is no yearly limit to how much you can give as monetary gifts, but you will need to pay an additional gift tax above a certain limit set by the IRS yearly.

Some States have a total contribution limit, designed to prevent excess contributions. Remember, the goal is to be able to afford education. Check each program’s total limits for more details.

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