Everything You Need to Know About 529 Savings Plans

Everything You Need to Know About 529 Savings Plans

•  3 minute read

Ever wonder what 529 savings plans are and whether they're right for you? Read this article to help you decide. We break it down for you.

No forum on higher education and student loans would be complete without information on 529 savings plans. Created in 1996, the “529” refers to the IRS code that authorizes these plans. Legally, you may know them as “qualified tuition plans.”

Everything You Need to Know About 529 Savings Plans. No forum on higher education and student loans would be complete without information on 529 savings plans.

 

In layman’s terms, these are savings plans designed to encourage people to save for college or other post-secondary education by offering tax breaks.

 

Normally, the government will tax all investment income. But the earnings on these investments are not subject to federal income tax as long as the withdrawals are used for higher education expenses. If you withdraw the money and use it for some other purpose, the earnings will be subject to a 10 percent penalty in addition to income taxes.

 

States actually administer many of these plans, so each state has slightly different rules. Most states also exempt the earnings on these accounts from state income taxes. Some states provide further incentives by allowing tax deductions for the contributions themselves. It’s kind of like an IRA.

 

The Two Types of Savings Plans

 

The prepaid tuition plan depends on your residency. It’s a state plan where you prepay for credits or tuition at participating state institutions. The college savings plan is a general savings plan. You can use it for tuition, room and board, fees, books, and even a computer for undergraduate, graduate, or vocational school.

 

States can offer both types of plans. But individual educational institutions (if they qualify) can only offer the prepaid tuition plan. The Securities and Exchange Commission website has good information on 529 savings plans. This includes a comparison of the two types of plans and a list of questions to ask when considering opening an account under this plan. You may not have to limit yourself to your own state’s plans.

 

Whoever owns the plan controls the withdrawals.

 

Plan owners also make the investment decisions if options are available for the specific plan. Each plan designates one beneficiary. These plans are popular for parents and grandparents to establish for children. However, they’re also popular for adults who want to go to (or return to) college.

 

 

Common Questions and Answers:

 

What happens if the beneficiary doesn’t want to go to college or doesn’t need everything in the savings plan? 

 

The fund can transfer to another family member, such as a sibling, grandchild, or even the account holder. Check out Kathryn Flynn’s article, “7 Myths and Realities of 529 plans,” for more information about the possibilities.

 

What is the maximum a person can contribute to the plan per year?

 

529 savings plans fall under the annual gift tax exclusion of $14,000 per person, per year (for 2015 and 2016). Any single individual can put in $14,000 per year into one account. They can also make a five-year, up-front contribution of $70,000. This is assuming that the contribution doesn’t take the balance over the maximum allowed by each state.

 

How would a 529 savings plan affect a student’s financial aid award?

 

Since 2006, both plans fall under “parental assets” when calculating the expected family contribution. In other words, it gets included with the parents’ other cash and investment accounts. As such, a portion of it is assumed to be available to go towards college in any given year.

 

I personally feel that parents should be maximizing their own retirement savings before putting money aside for college, if they can’t do both. Regardless, I think contributions to 529 savings plans are a great idea for anyone who wants to give your child a gift. In a day and age when couples ask for cash for their honeymoon or other expenditures as wedding gifts, and people go online to crowdfund their latest adventure, asking folks to help your child with future college expenses would be reasonable and socially acceptable. You can read articles on “gifting” to 529 savings plans to figure out how to manage the process. People can make contributions as low as $25 into these accounts.