Understanding 529 Plans: A Comprehensive Guide to College Savings

Every parent dreams of sending his or her child to college - but making this dream a reality can often feel like an insurmountable task. Fortunately, you have options as a parent. A 529 college savings plan, for example, could help you sock away money for your child's future higher education expenses. A 529 plan is a simple and flexible way to save for education expenses while taking advantage of potential tax benefits.

What is a 529 Plan?

A 529 plan, also called a qualified tuition program, is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary. A 529 plan is a state-sponsored account that helps families save for future education costs. Named after Section 529 of the Internal Revenue Code, it offers flexibility and potential tax benefits for qualified expenses like tuition, books, supplies, and room and board. A Section 529 plan is a tax-advantaged state-administered investment program that is authorized under Internal Revenue Code Section 529. These plans allow participants to save money in an account in which the earnings will grow free from federal income tax and, when used to pay for “qualified expenses” may be withdrawn federal income tax-free.

Types of 529 Plans

There are two main types of 529 plans: Prepaid Tuition Plans and College Savings Plans. Both can help pay for future education, but they work differently.

Prepaid Tuition Plans

With tuition credit plans, you purchase credits at participating colleges and universities, locking in today’s tuition rates for future use. This approach helps protect against rising tuition costs because the value of the credits stays tied to tuition over time. Essentially, parents, grandparents, and other interested parties may purchase future tuition at a set price today. The program will then pay the future college tuition of the beneficiary at any of the state’s eligible colleges or universities (or comparable payment to private or out-of-state institutions). Amounts of tuition (years or units) may be purchased through a one-time lump sum purchase or monthly installment payments.

Prepaid tuition plan benefits are generally designed to be used at in-state public universities and community colleges; however, in some cases, they can also be used at private institutions and at out-of-state public and private colleges and universities.

College Savings Plans

These accounts work by investing money in portfolios, often made up of mutual funds or ETFs. Investments in these accounts are subject to market fluctuations, meaning balances can rise or fall over time. Savings plans (also known as investment plans) enable participants to save money in a college savings account on behalf of a designated beneficiary. Amounts contributed and any earnings on the account may then be used to pay the beneficiary’s qualified expenses. Contributions can vary, depending on individual savings goals.

How a 529 Plan Works

You contribute money to the account, where the funds are invested and have the potential to grow over time, though they may also lose value. When it comes time to pay for education, you can withdraw the funds to cover qualified educational expenses at accredited institutions. These accounts are flexible, allowing you to transfer them to another qualified family member of the beneficiary if needed. Additionally, there’s no limit to the number of 529 plans a person can open. The funds from a 529 plan are used for qualified education expenses. These expenses are typically tuition, fees, textbooks, computers and equipment and are charged to the student in relation to attending an institution defined as any eligible public, non-profit or private college or university, technical, vocational, or trade institutions. For expenses to qualify, the student must be enrolled for at least half the full-time academic workload for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled. Department of Education.

Contribution Rules

Maximum contributions vary by plan. An individual may contribute up to $17,000 annually ($34,000 for married couples filing jointly) without paying gift taxes or filing a gift tax return (assuming no other gifts are made to the beneficiary in the same year).

Annual contributions up to $19,000 from an individual tax filer ($38,000 for married-filing-jointly) per beneficiary are not subject to the federal gift or estate tax consequences. An accelerated transfer to a 529 plan (for a given beneficiary) of $95,000 (or $190,000 combined for spouses who gift split) will not result in federal transfer tax or use of any portion of the applicable federal transfer tax exemption and/or credit amounts if no further annual exclusion gifts and/or generation-skipping transfers to the same beneficiary are made over the five-year period and if the transfer is reported as a series of five equal annual transfers on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.

Contributions to 529 plans are considered gifts under the federal gift tax regulations and hence any contributions in excess of the annual exclusion. The annual exclusion in 2024 is $18,000 if filing single (or $90,000 over five years) or $36,000 if filing married jointly (or $180,000 over a five-year period) count against the one-time gift/estate tax exemption.

Read also: Phoenix Suns' New Center

Qualified Expenses

A 529 college savings plan can only be used for qualified education expenses. Using funds for non-qualified expenses could result in taxes and penalties, so it’s important to plan carefully. Qualified expenses include tuition, mandatory fees, books, supplies, and technology and other software or equipment required for enrollment or attendance. In addition, qualified higher education expenses also include expenses of a special needs beneficiary that are necessary in connection with his or her enrollment or attendance at an eligible educational institution.

Room and board are also considered eligible expenses for both on-campus and off-campus housing. For on-campus housing - the expense allowed is the actual amount charged if the student is residing in housing owned or operated by the school. For off-campus housing - the expense is allowed up to the amount allowed for on-campus room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student. 529 plan qualified expenses for off-campus housing are not limited to rent. They can include groceries and utilities.

Qualified education expenses formerly did not include student loans and student loan interest. Federal tax treatment of a 529 plan’s qualified higher education expenses (QHEEs) includes the repayment of up to $10,000 (including principal and interest) on any qualified education loan of either a 529 plan designated beneficiary or a sibling of the designated beneficiary.

As part of the Tax Cuts and Jobs Act of 2017, eligible expenses for 529 plans may now include up to $10,000 in student loans of the beneficiary and certain K-12 tuition related expenses. Earnings on non-qualified withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes.

529 assets may be used to pay for (i) qualified higher education expenses, (ii) qualified expenses for registered apprenticeship programs, (iii) up to $10,000 per taxable year per beneficiary for tuition expenses ($20,000 for expenses beginning in taxable years after December 31, 2025) in connection with enrollment at a public, private, and religious elementary and secondary educational institution. Although such assets may come from multiple 529 accounts, the $10,000 qualified withdrawal ($20,000 beginning in taxable years after December 31, 2025) limit will be aggregated on a per beneficiary basis. The IRS has not provided guidance to date on the methodology of allocating the $10,000 annual maximum ($20,000 beginning in taxable years after December 31, 2025) among withdrawals from different 529 accounts, (iv) amounts paid as principal or interest on any qualified education loan of a 529 plan designated beneficiary or a sibling of the designated beneficiary. The amount treated as a qualified expense is subject to a lifetime limit of $10,000 per individual. Although the assets may come from multiple 529 accounts, the $10,000 withdrawal limit for qualified educational loans payments will be aggregated on a per individual basis.

Read also: About Grossmont Community College

Tax Advantages of 529 Plans

A 529 plan offers tax-free growth to help you fund future education expenses. When you contribute to a Bright Start 529 Plan account, any earnings are federal and Illinois income tax-deferred until withdrawn. Then withdrawals used to pay for qualified education expenses are federal tax-free.

First, although contributions are not deductible from the donor's federal income tax liability, many states provide state income tax benefits for all or part of the contributions of the donor. Many states give the account owner a full or partial state income tax deduction or tax credit for their contributions to the state's section 529 plans. So far a total of 35 states and the District of Columbia offer such a deduction. California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina currently have state income taxes but do not offer a state income tax deduction or tax credit for contributions to the state's 529 college savings plan. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, New Hampshire, Washington and Wyoming do not have state income taxes. Contributions to other states' section 529 plans are generally not deductible in the account holder's home state.

State Tax Benefits

Indiana taxpayers are eligible for a state income tax credit of 20% of contributions to an Indiana 529 Plan, up to $1,500 credit per year ($750 for married couples filing separately). Effective January 1, 2024, rollover contributions and contributions generated through a rewards program are not eligible for the credit. Effective January 1, 2023, the definition of an Indiana taxpayer was revised to include married individuals filing separately. The maximum annual credit allowed for a married taxpayer filing separately is $750. Indiana residents may elect to treat contributions made through the deadline (excluding extensions) for filing an individual Indiana state income tax return (generally April 15) as having been made in the prior year in order to claim the allowable annual credit on their Indiana state tax return for the prior year.

An individual who files an individual Illinois state income tax return will be able to deduct up to $10,000 per tax year (up to $20,000 for married taxpayers filing a joint Illinois state income tax return) for their total, combined contributions to the Bright Start Direct-Sold College Savings Program, the Bright Directions Advisor-Guided 529 College Savings Program and College Illinois! during that tax year. The $10,000 (individual) and $20,000 (joint) limit on deductions will apply to total contributions made without regard to whether the contributions are made to a single account or more than one account. The amount of any deduction previously taken for Illinois income tax purposes is added back to Illinois taxable income in the event an account owner makes an Illinois nonqualified withdrawal from an account. You should consult with your financial, tax or other advisor regarding your individual situation.

Taxpayers may deduct from individual Virginia taxable income contributions of up to $4,000 per account per year made to an Invest529 account.

Tax-Free Withdrawals

If you are making a withdrawal to cover a qualified education expense for the beneficiary, you are not subject to federal tax. Withdrawals for K-12 tuition expenses are free from Federal and Virginia state taxes.

Rollover to Roth IRA

The SECURE 2.0 Act of January 2023 allows for tax and penalty-free rollovers from 529 accounts to Roth IRAs, under certain conditions. Beneficiaries of 529 college savings accounts would be permitted to rollover up to $35,000 over the course of their lifetime from any 529 account in their name to their Roth IRA.

Beginning January 2024, the Secure 2.0 Act of 2022 (the "Act") provides that you may transfer assets from your 529 account to a Roth IRA established for the Designated Beneficiary of a 529 account under the following conditions: (i) the 529 account must be maintained for the Designated Beneficiary for at least 15 years, (ii) the transfer amount must come from contributions made to the 529 account at least five years prior to the 529-to-Roth IRA transfer date, (iii) the Roth IRA must be established in the name of the Designated Beneficiary of the 529 account, (iv) the amount transferred to a Roth IRA is limited to the annual Roth IRA contribution limit, and (v) the aggregate amount transferred from a 529 account to a Roth IRA may not exceed $35,000 per individual. It is your responsibility to maintain adequate records and documentation on your accounts to ensure you comply with the 529-to-Roth IRA transfer requirements set forth in the Internal Revenue Code. The Internal Revenue Service (“IRS”) has not issued guidance on the 529-to-Roth IRA transfer provision in the Act but is anticipated to do so in the future. Based on forthcoming guidance, it may be necessary to change or modify some 529-to-Roth IRA transfer requirements. Please consult a financial or tax professional regarding your specific circumstances before making any investment decision.

Who Can Open and Benefit from a 529 Plan?

Everyone is eligible to take advantage of a 529 plan. A 529 account can be opened by anyone. Grandparents, other relatives or family friends can all be account owners, or simply choose to contribute to an existing account.

Generally, anyone can be named the beneficiary of a 529 account regardless of their relationship to the person who establishes the account. You can even establish an account with yourself as the named beneficiary. The only requirement is that the beneficiary must be a US citizen or a resident alien, and must have a social security number or federal tax identification number.

A beneficiary may have more than one Bright Start 529 account. For example, a beneficiary may have an account owned by their parent and/or grandparent and/or aunt, etc. There is an overall maximum account balance limit for accounts for a beneficiary in the plan and any additional accounts in other Illinois Section 529 programs of $500,000. On January 31, 2026, the amount will increase to $550,000.

Flexibility in Usage

Funds can be used at any eligible educational institution in the country-and even some abroad. “Eligible educational institutions” are accredited post-secondary educational institutions offering credit toward a bachelor’s degree, an associate degree, a graduate level or professional degree, or another recognized post-secondary credential. Certain proprietary institutions and post-secondary vocational institutions and certain institutions located in foreign countries are also eligible educational institutions.

If the money in a 529 plan isn’t used, the account owner can change the beneficiary to another family member or save it for future education expenses. Account benefits can be transferred to a member of the current student’s family without penalty. Penalties may apply if transferred to an individual who is not a member of the current student’s family.

Potential Drawbacks

The earnings portion of money withdrawn from a 529 plan that is not spent on eligible expenses (or rolled over into an ABLE account for any eligible family member) is subject to income tax, an additional 10% federal tax penalty, and the possibility of a recapture of any state tax deductions or credits taken. Non-qualified withdrawals are taxable as ordinary income and, unless an exception applies, are subject to a federal penalty of 10 percent. Each state’s tax rules may differ in its treatment of income from a 529 plan, so it’s important to check with your state or consult a tax advisor regarding specific tax consequences taking withdrawals.

Paying college expenses directly from a 529 account may reduce eligibility for the American Opportunity Tax Credit, due to IRS coordination restrictions.

The 529 plan for the state in which one is domiciled may have higher fees (expense ratios) - which are not required to be disclosed in marketing materials and can range from under 0.4% to more than 1.1% - than the plans of other states.

529 Plans and Financial Aid

Like any non-retirement investment or savings, 529 accounts may affect eligibility for need-based financial aid - however, the impact is minimal. For accounts owned by parents and dependent students, the Free Application for Federal Student Aid (FAFSA) assesses 529 assets at about 5.64 percent of the value when calculating the Student Aid Index (SAI) for financial aid eligibility. Accounts owned by other parties will impact eligibility differently.

When it comes to financial aid, ANY assets that you or the beneficiary own (not just 529 plan assets) can affect your eligibility for need-based financial aid. With 529 plans, your account is considered to be an asset of the account owner. Assuming the account owner is the parent, this means that, on average, about 5.6 percent of the value of the account is considered in determining the Expected Family Contributions (EFC). The EFC is the amount the family of the beneficiary is expected to pay toward that beneficiary’s higher education.

Beginning in 2024-2025, 529 accounts will only be counted as a parental asset if the account is designated for the student. Student Aid Index (SAI) will replace Expected Family Contribution (EFC) for 2024-25. Some schools require additional information to determine financial aid awards. Inclusion of accounts owned by someone other than the student or custodial parent depend on the school’s requirements. The best resource for detailed financial aid information is your school’s financial aid office or a college access or financial aid advisor in your area.

ABLE Plans

529 ABLE accounts let Americans with disabilities save tax-deferred for education and other expenses without impacting eligibility for public benefits. INvestABLE Indiana is offered through the National ABLE Alliance. INvestABLE is established under the state's ABLE legislation and Section 529A to encourage and assist individuals and families in saving private funds for the purpose of supporting individuals with disabilities.

Yes, families who have an Invest529 account can transfer funds to an ABLEnow account without incurring any tax or penalty. However, the amount transferred from the Invest529 account may not exceed the annual ABLE contribution limit, including any amounts previously contributed to the ABLEnow account. Both the 529 and ABLEnow accounts must have the same beneficiary, or the new ABLEnow beneficiary must be an ABLE-eligible “Member of the Family” as defined by IRC Section 529A(e)(4).

History of 529 Plans

529 college savings plans originated from states rather than the federal government. With tuition cost increasing year by year, the state-run prepaid tuition program of Michigan addressed the increasing anxiety on the part of many thousands of Michigan households with the Michigan Education Trust (MET) proposition. This created a fund to which the state's residents could pay a fixed amount in exchange for tuition increases.

Michigan delayed its own launch so that a ruling could be requested from the Internal Revenue Service (IRS) regarding the tax aspect of arrangement. The IRS allowed purchasers of the "prepaid tuition contract" to not be taxed on the accruing value of the contract until the year in which funds were distributed or refunded.

Subsequently, Congress has passed new legislation authorizing qualified state tuition programs. This is now part of the Small Business Job Protection Act of 1996. Section 529 advanced to the Clinton administration's agenda and became part of Taxpayer Relief Act of 1997 (TRA). Another provision was added to the bill to make Section 529 distributions tax-free, not just tax deferred when used for college.

Changes to the structure and marketing of 529 plans over the years have contributed to their growth. The states partnered up with the professional investment community, which allowed them to offer 529 plans with the feel of mutual funds.

In 2014, Congress passed the Achieving a Better Life Experience (ABLE) Act, laying the groundwork for ABLE accounts.

The Tax Cuts and Jobs Act of 2017 expanded 529 plans to include K-12 public, private, and religious school tuition.

The SECURE Act further expanded the use of 529 plans to cover student loan repayments.

Direct Sold vs. Advisor Sold 529 Plans

Direct sold 529 plans are "do-it-yourself" type plans in which the saver enrolls and sets up the initial investment. Fortunately most 529 plans make this simple! You'll pay no sales charges beyond fund and administrative fees.

Advisor sold 529 plans are plans offered by investment professionals. Ideal for those investors who value the guidance of a financial advisor on their savings journey. Advisor sales charges and/or fees may apply.

tags: #college #choice #direct #definition