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A 529 plan is a financial account designed to help families save for college, trade schools, and K-12 expenses.
Typically 529 plans refer to tax-advantaged investment accounts that allow you to invest funds in managed portfolios in order to pay down a child's future education.
In other words, you can open a 529 account for your child, with the goal of paying down the child’s (often high) education expenses.
529 Plans are named after the IRS code Section 529.
529s are established and maintained by a State, an agency, or an educational institution. Using a 529 plan, 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 for your child, with the goal of paying down the child’s (often high) education expenses.
529 accounts are offered by states, brokerages, and some colleges.
Some 529 plans are limited to residents of certain States, but many 529 plans are open for enrollment nationally.
There are two types of 529 accounts - 529 Education Savings Plans and Prepaid Tuition Plans. The first is more common, a tax-advantaged investment account and the second is a program that lets you pre-purchase college credits at today’s prices.
The 529 Education Savings Plan is a tax-advantaged 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 college tuition, room & board, and other qualified expenses (more below). You can also use up to $10,000 per year to pay for K-12 tuition per child.
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).
The 529 Education Savings Plan is a tax-advantaged investment account that lets you invest money in the market and provides tax benefits on the profit you make from your investments.
Many 529 programs offer managed portfolios that you can choose from that already mix different investment options, eliminating the need to pick and choose individual investments.
This makes 529 college accounts great for people who prefer a hands-off approach to growing their investments.
On top of that, many 529 funds 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.
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.
Prepaid Tuition 529 Plan 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.
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.
Your tax savings on $200 monthly investment 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
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%.
For example - if you save and invest $200 monthly 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 $52,817 for 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 UTMA account.
You can only spend your 529 funds on an expense that is pre-approved by Internal Revenue Code Section 529. Otherwise, you will need to pay the capital gains taxes plus a penalty.
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 up to $10,000 per year of student loans with a 529 account.
This is the full list of qualified 529 expenses:
For Private, Public or Religious Elementary and Secondary Schools:
For College or Apprenticeship Programs:
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 you use the funds for anything other than a qualified expense, you will need to pay taxes on the earnings plus a 10% penalty on the earnings
If for example over the years you managed to contribute $15,000, and that investment grew by an additional $7,500 for 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 $7,500 earnings portion.
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 of interest in this scenario! This is what makes 529 accounts better the regular savings accounts.
There are a few advantages to saving for higher education with this a 529 account.
The tax benefits can be substantial over the course of 18 years (or even less). Compound interest can multiply your contributions into 529 plans over 18 years. These earings would be subject to capital gains taxes, but if invested through a 529 and used for a qualified education expense become tax free.
There are two main advantages to saving for higher education with this a 529 account.
Secondly, earmarking money towards a specific goal is often a strong driver to achieving that goal.
If you open a 529 plan with the goal of affording college for your kid, you increase the chances your kid will go to college.
Separating the funds from your own into a college savings account helps to plan financially for college expenses.
Lastly, unlike a custodial account where the funds are automatically transferred to the child at adulthood, 529 plans remain in the account owner's control.
The investments made in 529 accounts are meant to be used for education expenses and college costs.
However, if the child decides not to go to college, you may need to find what to do with the funds, or pay the penalty and taxes on the account's earnings.
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 Direct 529 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.
There are over 100 529 plans to choose from, so picking the best one can be hard.
Here are a few factors to consider when comparing 529 plans:
Unlike with a custodial account, 529 plans remain in the account owner's control when the beneficiary (the child) becomes an adult.
The account owner, typically the parent, guardian or grandparent, remains in control of the account funds and assets, and can make decisions on how to spend them.
Many parents consider this to be a major advantage over custodial accounts where control is automatically transferred to the new young adults.
The account owner, usually a responsible adult, can make sure the funds are used appropriately for a good goal and aren't wasted.
The account owner can choose to withdraw funds to pay down the beneficiary's education bills, withdraw them for an unqualified expense (and pay the taxes and penalty), or even transfer the account beneficiary to another family member.
You have a few options if your child doesn’t end up going to college.
If you have anyone else in the family that could benefit from the 529, you can change the plan’s designated beneficiary
One option is to withdraw the money from the account and simply pay the income taxes and the penalty on the account's earnings.
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.
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.
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 the annual exclusion rate for monetary gifts set by the IRS yearly.
In 2023, the maximum contribution limit for a gift giver to the same recipient is $17,000. Above this amount, the gift giver will need to fill out form 709 of the IRS and potentially pay gift taxes.
If you're looking to deposit more than $17,000 in a single year, you're in luck. 529 plans allow spreading a one time contribution over 5 years, an action typically known as a superfunding.
The contribution is considered as if it were made over 5 years and needs to be reported every year for 5 years in a 709 form.
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.
