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What You Need To Know About 529 Plans

What You Need To Know About 529 Plans

June 07, 2023

As the cost of higher education continues to rise, parents and families are increasingly seeking effective ways to save and invest for future education expenses. One popular option that has gained significant traction is the 529 plan. These state-sponsored savings plans offer numerous benefits which include:

Tax-Deferral and Tax-Free Distributions: One of the most attractive features of 529 plans is the potential for tax-deferred growth and tax-free distributions. Contributions made to a 529 plan are not tax-deductible at the federal level, but the earnings within the plan grow tax-free. As long as the funds are used for qualified education expenses, withdrawals are exempt from federal income tax.  These include:

  • College tuition and fees
  • Room and board
  • Books
  • Computers and other supplies
  • Required equipment
  • Additional expenses of a special-needs beneficiary
  • Private K through 12 tuition expenses of up to $10,000*
  • $10,000 in qualified student loan repayments per 529 plan beneficiary
  • Roth IRA Rollovers*

Favorable Gifting Strategies: 529 plans offer unique gifting strategies that can benefit both contributors and beneficiaries. Individuals can make contributions up to the annual gift tax exclusion amount ($17,000 per person/$34,000 per couple in 2023) without incurring gift taxes. Additionally, there is an option to make a lump sum contribution of up to five times the annual gift tax exclusion amount ($85,000 per person/$170,000 per couple in 2023) without triggering gift taxes, as long as no further gifts are made to the same beneficiary for the next five years.  You can also use your unified credit to gift the maximum contribution per beneficiary (typically $400,000-$550,000, including earnings, per beneficiary depending on the 529 plan used). Because there are no restrictions on who you can open an account for, or how many beneficiaries you can make contributions for, you are able to move considerable assets out of your estate while you still retain control of the assets and withdrawals. 

Multiple Investment Choices: 529 plans provide investors with a range of investment options to suit their risk tolerance and financial goals. These options typically include age-based portfolios that automatically adjust the asset allocation as the beneficiary gets closer to college age, as well as individual portfolios that allow investors to choose specific investments.

Flexibility for a Variety of Education Choices: 529 plans offer flexibility when it comes to the type of education the funds can be used for.

No Income, Age, or Loss of Control Limits: Unlike some other education savings options, 529 plans have no income limitations, making them accessible to families of various income levels. There are also no age limits for beneficiaries, allowing individuals to start saving at any stage of life. Parents (or grandparents) also retain control over the funds and can change the beneficiary if needed.

Roth IRA Rollovers: Beginning in 2024, you can potentially rollover up to $35,000 into a Roth IRA for the beneficiary of the 529 plan.  To do this, the account must’ve been opened for at least 15 years and the funds that have been in the plan for at least five years are eligible for a rollover.  The annual contribution limits still apply in this scenario (you can’t make a maximum annual contribution and do a rollover in the same year), so it will take about 5-6 years to rollover the maximum amount (assuming a $6,500 rollover/year).  Fortunately, the Roth IRA income limitations are waived with regards to a Roth IRA rollover.

However, it's important to note that non-qualified expenses, such as transportation and travel, general electronics, and certain fitness club memberships, are not covered by 529 plans. Using funds for non-qualified expenses may result in federal and state income taxes, plus a 10% penalty. State tax breaks received may also need to be repaid. The 10% penalty may be waived if:

  • The beneficiary dies or becomes disabled
  • The beneficiary receives a tax-free scholarship
  • The beneficiary receives educational assistance through a qualifying employer program
  • The beneficiary attends a US Service Academy

529 plans offer a powerful way to save for higher education while enjoying tax advantages and investment flexibility. By understanding the qualified expenses and considering state-specific rules, families can make informed decisions to secure a brighter future for their loved ones and alleviate the financial burden of education.

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*Some states don’t consider withdrawals from a 529 plan to pay for primary or secondary school costs a permissible expense.  Additionally, they may not allow for the Roth IRA rollover option either.  The tax consequences of such payments will vary depending on state law and may included penalties.  Please consult with a tax or legal professional prior to consideration.