The Benefits of Using a 529 Plan for College Savings
In the ever-evolving landscape of higher education, planning and saving for college has never been more crucial. With tuition costs rising annually, families are seeking effective ways to secure their children’s educational future without incurring debilitating debt. One of the most efficient and advantageous methods to save for college is through a 529 plan. Let's delve into the benefits of using a 529 plan for college savings.
What is a 529 Plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. Named after Section 529 of the Internal Revenue Code, these plans are sponsored by states, state agencies, or educational institutions and come in two primary forms: Prepaid Tuition Plans and College Savings Plans.
Tax Benefits
Tax-Free Growth: The most significant advantage of a 529 plan is that the earnings grow federal tax-free and will not be taxed when the money is withdrawn to pay for qualified education expenses, such as tuition, fees, books, and room and board.
State Tax Benefits: Many states offer tax deductions or credits for contributions to a 529 plan, providing an immediate benefit to savers. The specifics vary by state, for example, Missouri is one of nine states that offer tax parity. This means the plan can be under any state, and you still receive a tax deduction on your state income taxes. Illinois on the other hand does not have tax parity, and you must use their in-state plan to get the state income tax deduction.
Flexibility and Control
Broad Usage: While originally intended solely for college expenses, the scope of 529 plans has expanded. They can now be used to pay for K-12 tuition (up to $10,000 per year), apprenticeships, and even to pay off student loans (up to a $10,000 lifetime limit). And, if the beneficiary does not intend to use the funds for school, they can roll the money into a Roth IRA (subject to a $35,000 lifetime cap).
Account Control: The account owner retains control of the funds, regardless of the beneficiary’s age. This means the owner decides when withdrawals are made and for what purpose, provided it’s a qualified expense.
Changing Beneficiaries: If the initial beneficiary decides not to attend college, you can change the beneficiary to another qualifying family member without penalty. This flexibility ensures that the funds can still be used for educational purposes within the family.
Financial Aid and Scholarships
Financial Aid Impact: A 529 plan is considered a parental asset if the account owner is a parent, which typically has a lower impact on financial aid eligibility compared to assets in the student's name. Only up to 5.64% of the asset's value is considered for federal financial aid calculations.
Scholarship Considerations: If the beneficiary receives a scholarship, you can withdraw an amount equal to the scholarship from the 529 plan without incurring the 10% penalty. However, you will have to pay taxes on the earnings portion of the withdrawal.
Estate Planning Benefits
Gift Tax Exclusions: Contributions to a 529 plan qualify for the annual gift tax exclusion. As of 2024, individuals can contribute up to $17,000 per beneficiary per year without triggering gift taxes. There is also a special provision that allows for five years' worth of contributions to be made in a single year, per beneficiary, without incurring gift tax (totaling up to $85,000 for individuals or $170,000 for married couples).
Removing Assets from Estate: Contributions are considered completed gifts to the beneficiary, meaning they are removed from the donor’s taxable estate, which can be advantageous for estate planning purposes.
Investing in a 529 plan is a strategic move for families looking to balance the costs of higher education with smart, tax-advantaged savings. The combination of tax benefits, flexibility, control, and minimal impact on financial aid makes it a standout choice in the realm of college savings. As education costs continue to rise, utilizing a 529 plan can provide peace of mind and financial security, ensuring that your children can pursue their academic dreams without the burden of overwhelming debt.
By understanding and leveraging the benefits of a 529 plan, you can take a proactive step towards securing a brighter future for your loved ones. If you would like to read about other techniques and strategies to save for college, check out our free eBook,
At SDSmith Financial, we do not charge for 529 Plans, so, if you are interested in setting one up for a loved one, set up an initial consultation here! As always, thanks for reading!
Disclosure: Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer's official statement and should be read carefully before investing. Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investment in any state's 529 Plan.