Chances are you’ve heard of a 529 Plan, but maybe don’t fully understand what they are or why you would want to open one. Below, we’ve broken it down to the basics and provided some helpful links so you can decide if a 529 Plan is right for you. If not, at least you’ll be “in-the-know” next time they come up. So, first things first:
What is a 529 Plan?
A 529 plan is a college or education savings plan that offers tax and financial aid benefits. There are two types of 529 plans: prepaid tuition plans and college savings plans. The prepaid tuition plan allows you to lock into current tuition rates by pre-paying for it now. There are slight variations on this plan, however, the main idea is that the costs of college are increasing at roughly twice the rate of inflation. By locking in rates now, you are saving money in the future. Alternatively, the college savings plan allows you to save funds in a tax-advantageous way that can later be used to pay for qualified tuition and education related expenses. The latter of these two options is the most popular because it offers the beneficiary more flexibility with how and where the funds are used. For this reason, we will focus on the popular “college savings plan” in this post.
Please note, when researching outside of this post you might see these plans referred to by more than one name (which is a common theme in the finance world), such as “qualified tuition programs” and “Section 529 plans.” They are all the same thing. For clarity’s sake, we will just call them 529 Plans here.
How do I open a 529 Plan?
Any adult can open a 529 Plan, and it is surprisingly quick and easy to do. Most accounts can be opened online which helps speed up the process. Before opening a 529 Plan you’ll want to have certain details on hand including:
(1) your Social Security Number.
(2) your beneficiary's full name, date of birth and Social Security Number.
(3) your bank account and routing information (so you can electronically deposit funds upon opening).
This type of account is typically established by parents or grandparents on behalf of a child or grandchild (who is referred to as the account's beneficiary). However, it is good to know that anyone can benefit from a 529 Plan - they are not just for kids. You can open one for yourself or anyone else interested in continuing their education as an adult. It’s a fantastic opportunity to invest in furthering your own career and education in a tax advantaged way.
Where can I open a 529 Plan?
Unlike retirement and other investment accounts, 529 plans are generally operated by each state. Therefore, every plan operates under different rules and has different potential tax benefits. Almost every state has at least one (if not many) plans available to choose from. You can open one in any state, not just the state you or the beneficiary live in. However, account owners often receive the best tax benefits from opening accounts in their state of residency. There are also some plans, like American Funds’ CollegeAmerica, run by financial institutions which you can open with the help of your financial advisor. While less talked about, there are also 529 plans operated by private colleges and universities. We’ve provided links below that you might find helpful:
Browse plans by state here: https://www.savingforcollege.com/529_plan_details/
Browse private college plans here: https://privatecollege529.com/participating-schools/
Browse by state plans with tax notes here: https://www.nerdwallet.com/blog/investing/529-plans-list/
Who can contribute?
Good news: Anyone can contribute to an existing 529 Plan. As the account owner, you have control over the account and funds inside, and are ultimately responsible for making any decisions on it. However, you may not necessarily need to fund the account entirely out of your own pocket. Many account owners find that their friends and family are eager to support their child or grandchild’s education. Plan providers often have contribution links which you can share during holidays and birthdays in-lieu of asking for traditional gifts. Depending on the plan rules, some of those gift-givers might even enjoy tax benefits from contributing to the plan (although this varies greatly by plan and the gift-giver’s state of residence).
It is largely uncommon for companies to allow 529 Plan contributions through payroll deduction and even less likely that they offer matching contributions. In fact, according to Kathryn Flynn at savingforcollege.com, only 2% of HR professionals “work for employers who offer 529 plan contributions or matching contributions.” While rare, it never hurts to ask your employer if this is something they offer. You might be one of the lucky few who can take advantage of this option.
How much can I contribute?
While minimums vary by plan, there are some important details about maximums that you should know. Every year you can contribute up to $15,000 per child ($30,000 for married couples) without gift tax consequences. Under a special election, you can contribute up to five years at once (up to $75,000, or $150,000 for a couple) without it counting against the lifetime gift tax. Remember, these guidelines are true whether you are contributing to an account you open or one that someone else has already created. The five-year contribution feature is often overlooked and underutilized by those who could greatly benefit in their tax and estate plans; Check with your tax consultant and then contact us to open an account and take advantage of this life-time exemption.
Why would I want to open one?
There are many reasons someone might want to open a 529 Plan. Here’s our favorite three:
Tax Benefits Now. Contributions you make each year are tax deductible (limits apply).
Tax Benefits Later. The money you invest now can grow and be withdrawn later as tax-free money. (Think of it like “roth” money).
Potential for higher earnings over the recipient’s life time. Higher education is expensive and difficult for many to afford, however, it can really pay off in the long run. According to the Social Security Administration, “there are substantial differences in lifetime earnings by educational attainment. Men with bachelor's degrees earn approximately $900,000 more in median lifetime earnings than high school graduates. Women with bachelor's degrees earn $630,000 more. Men with graduate degrees earn $1.5 million more [and] Women with graduate degrees earn $1.1 million more.” A 529 Plan can help you or your loved ones attain this important boost in education and therefore increase in income over a lifetime.
“Children with college savings plans have higher college-going rates and are more likely to graduate from college than those with no savings. Even with savings of less than $500, a child is 25% more likely to enroll in college and 64% more likely to graduate than a child with no savings.”
- Kristine Schaffer based on Center for a study by Social Development at Washington University in St. Louis (WUSTL).
Benefits of starting early.
No matter when you are able to start saving for education, it is something to be proud of. It’s an important investment in anyone’s life, and the earlier you are able to start saving the better. There are distinct benefits to saving early including personal finance learning opportunities, taking full advantage of the compounding effect, and increased likelihood of attending college.
Currently, personal finance lessons are not typical in mainstream education, and even less so during early childhood years. If you’ve opened an account on behalf of a child or grandchild, this can be a great learning opportunity for them to see how banks, deposits, statements, balancing, investing, and managing personal finances work in real life. It will better prepare them for managing their own finances when they become an adult.
Early investing also allows you to take full advantage of “compounding” benefits. Said differently, it allows your savings to grow dramatically over time without necessarily adding more money out of your own pocket. The idea is that every day you leave money invested, it is hopefully able to gain more interest and more value (capital gain). Those gains then become more magnified each day it remains invested. To demonstrate the principal, consider what would happen if you double a penny every day for 30 days. You would have over $5 million in just one month. While that rate of return is not likely to happen in your 529 Plan (or any investment for that matter), you are likely to have more money available for college expenses than if you did not invest at all - especially if you start early.
The importance of setting money aside becomes even more poignant when you consider that studies show people are more likely to enroll and earn a college degree if they have savings designated for education. In fact, “even with savings of less than $500, a child is 25% more likely to enroll in college and 64% more likely to graduate than a child with no savings…” Those are big increases in odds, for a relatively small investment.
What if they don’t go to college?
Think of opening a 529 like betting that someone will go to college and wanting to be as prepared as possible should that happen. Of course, sometimes the best laid plans don’t work out. So, what happens if there are changes of heart, unexpected life choices, accidents, deaths, or other events occur so that the beneficiary of your 529 Plan doesn’t go to college? If that happens, you generally have the following options:
They can use funds for qualified trade schools, apprenticeship, or similar programs.
You can roll the funds over to another beneficiary in the family, such as a sibling, who is planning on receiving higher education. Restrictions may vary between plans.
You can use funds for qualified pre-college expenses. Some states allow tax-free withdrawals of up to $10,000 for qualified K-12 education costs.
You can simply withdrawal funds and pay a penalty. Penalties vary by plan sponsor and circumstance, however, generally speaking, the earnings will be subject to a 10% federal tax penalty in addition to federal and sometimes state income tax.
If you end up in this situation, you should work with your financial advisor and tax professional so they can help identify the best solution for your unique situation.
What if there is money left over?
If you have money left over in the 529 Plan after the beneficiary attends college, you will have all the same options listed above in the “What if they don’t go to college” section. Thanks to the 2019 SECURE Act, you can also use remaining funds to repay student loans with tax-free dollars.
Interested in opening a 529 Plan?
We can help. Click here to contact our office for more information.
Still not sure if a 529 Plan is right for you?
Generally speaking, we find that 529 Plans are currently the best, most flexible college savings plan out there. However, if you want to learn about other available account types (such as the UTMA/UGMA & Coverdell) and how they compare to 529 Plans, Fidelity put together a great compare and contrast chart:
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Disclosure: Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses, summary prospectuses and 529 Product Program Description, which can be obtained from a financial professional and should be read carefully before investing. Depending on your state of residence, there may be an in-state plan that offers tax and other benefits which may include financial aid, scholarship funds, and protection from creditors. Before investing in any state's 529 plan, investors should consult a tax professional. If withdrawals from 529 plans are used for purposes other than qualified education, the earnings will be subject to a 10% federal tax penalty in addition to federal and, if applicable, state income tax.
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