What is a 529 plan?

What is a 529 plan? 

A 529 plan is a tax-advantaged investment account designed to encourage saving for future education expenses, such as college tuition, room and board, and other related fees. Anyone can open a 529 plan on behalf of a beneficiary, and there is no age restriction on when someone needs to draw on these funds. 

The main benefits of a 529 plan are tax-free withdrawals for certain education expenses, tax-deferred growth of earnings, and potential state tax deductions or credits for contributions made to the plan.  

What are the different types of 529 plans? 

There are two main types of 529 plans.  

The first is a 529 college saving plan. With this method, you will pay contributions into your account. These contributions are then invested in a pre-selected fund that will hopefully help the value of your account grow over time. Some 529 accounts come with target dates, which automatically adjust your investment funds as your beneficiary approaches college, making your investments and returns less risky the closer the beneficiary is to college. 

The second type of 529 plan is a prepaid tuition plan.  

These plans are much rarer. They involve setting funds aside to pay for a beneficiary’s tuition costs well before they go to college. In practice, you’ll pay for someone’s tuition costs at current levels, even if they won’t be heading to college for a few years. While the specific rules vary depending on the sponsor and account, the main difference between these accounts and college saving plans is that a prepaid tuition plan can only be used to cover tuition costs. 

What are the best 529 plans? 

529 plans are offered and managed by your state or a relevant higher educational institution. You can buy these accounts from these providers, or work with a financial advisor or broker to find one that suits your needs.  

Before comparing offers, it’s wise to have a rough idea of how much you want to contribute each month or the current tuition fees. This will give you an idea of the type of savings accounts you need to consider. Remember that states tend to offer only one 529 plan each, so if this doesn’t generate the right coverage for you, you may need to speak to a broker to find an alternative.  

What are the contribution limits to a 529 plan? 

As different institutions and states offer 529 plans, they each work in a slightly different way.  

However, as a general rule, you can often open a 529 plan with as little as $25 or sometimes no minimum deposit at all. There is also no annual limit to how much you can contribute to a 529 plan. However, once you have contributed more than your annual gift tax allowance, your 529 plan will become eligible for gift tax. In 2023, this allowance is up to $17,000 per donor per beneficiary.  

There are also some aggregate limits to 529 plans. These totals are the maximum you can contribute to a 529 account over its life, and the exact limits can vary from state to state. For example, the lowest aggregate limit is in Georgia, at $235,000, whereas the highest is in Missouri, at $550,000. 

What are the tax benefits of a 529 plan? 

529 accounts are tax efficient in a few ways.  

Firstly, a 529 plan is a tax-free way of gifting money to cover qualified educational expenses. Moreover, opening a 529 plan can make you eligible for several income tax credits and deductions. For example, in some states, your 529 contributions will be tax deductible, whereas, at the federal level, they are not.  

As mentioned above, 529 accounts count as financial gifts for federal tax purposes. This means you can contribute up to an annual threshold before you have to start paying gift tax, making 529 plans a tax-efficient way of gifting money to a loved one.  

Finally, you can use a 529 plan to minimize your estate tax. Account holders can donate money to these accounts to reduce the amount of cash in their estates – helping them pay less estate tax.  

How can I withdraw money from a 529 plan? 

Withdrawing funds from a 529 plan is easy.  

You can request a withdrawal by contacting your plan administrator, who can pay the funds directly to you, your beneficiary, or the educational institution directly. If you use your withdrawal to cover qualified expenses, it will be tax-free.  

You must ensure your withdrawal will go towards a qualified expense to avoid normal income tax rates or even sizable fees. Examples of non-qualified expenses include: 

What happens to money left in a 529 plan? 

Although a 529 plan is an excellent way of contributing towards someone’s educational costs, leftover money has been a major problem for families whose children have already graduated from college. In short, any money left in a 529 plan after graduation is effectively trapped – withdrawing funds for non-educational reasons has major tax and penalty implications. 

However, new legislation dictates that from 2024, leftover funds can be rolled into a Roth IRA retirement account. The new changes mean that an annual maximum of $6,500 can be contributed to a Roth IRA, up to a maximum of $35,000. The Roth IRA account must also be under the same name as the beneficiary of the 529 account.  

A 529 plan can be an excellent way of contributing toward someone’s educational future. Not only that, but it can also help you benefit from a range of tax advantages too. If you’re interested in opening a 529 plan, speak to a financial advisor and find a 529 plan that’s right for you.  

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