A 529 plan is among the powerful tools for people looking to invest in education, either for their child, grandchild, or even themselves. Did you know that the 529 plan was actually named after Section 529 of the Internal Revenue Code? In fact, for many people, this tax-advantaged savings plan is designed specifically to encourage saving for future educational purposes.
Now, at its core, a 529 plan provides you with two choices: a savings plan that works more like a retirement account by investing in mutual funds or other similar investments, and a prepaid tuition plan which helps you pay for future tuition fees.
But the question remains: When should you start saving in a 529 plan account? Well, given the rate of costs and inflation, you should start as early as possible, considering your family’s financial circumstances and the goals they have in mind. However, there is a lot more to this topic that you should know about.
From tax benefits to eligible expenses, let’s understand the nitty-gritty of a 529 plan. Continue reading to learn more about this plan. Let’s go!
Types of 529 Plans
529 plans are basically divided into two major types:
- 529 Savings Plan
- 529 Prepaid Tuition Plans
Let’s get into the details of both of them.
1. 529 Savings Plan
This is actually widely favored for the added effectiveness it has in education savings. In a 529 savings plan, contributors typically have to deposit funds, which are then invested as per a predetermined investment choice. In other words, investors are also free to choose their preferred investment options, usually mutual funds. You should know that the growth of these actually depend on the performance of the investments.
One of the major features of the 529 savings plan is target-date funds. In addition, when the beneficiary gets closer to college age, these funds automatically modify their investment strategy to become more conservative in line with their evolving risk tolerance.
In fact, any withdrawals made from the 529 savings plan can also potentially be used for K-12 qualified expenses and college. In other words, the qualified expenses can include anything between tuition, room, fees, and any other relevant cost.
After the SECURE Act, passed in 2019, the utility of 529 plans broadened. Now, you can ask how? Well, it allowed tax-free withdrawals for the types of expenses relevant to the registered apprenticeship programs. In fact, it is up to a solid $10,000 to help repay student loans for the beneficiary along with their siblings.
2. 529 Prepaid Tuition Plans
This plan actually helps you pre-purchase your future tuition at prices of today, allowing you to lock in current tuition rates to avoid the worry of inflation later in the day. Moreover, prepaid tuition plans are basically supported by state governments and require residency evidence.
Just like the 529 savings plan, prepaid tuition plans also keep growing in value over the course of time. However, keep in mind that prepaid tuition plans actually do not cover the expenses associated with room and board.
Be that as it may, the amount that is paid into a prepaid tuition plan is actually not guaranteed by the federal government, just as it is not guaranteed by a couple of states. It’s very important that you understand all the nooks and crannies of prepaid tuition plans.
Confused about 529 tax plans?
Why not seek help from experts!
Tax Benefits of 529 Plans
The 529 plans offer some of the most appealing tax benefits that make them a great tool for educational savings. Here are some of the key advantages:
Federal tax benefits
- Tax-deferred growth: The contributions you make to a 529 plan actually grow free of taxes. This gradually helps your money to compound faster and reach a more attractive value over the course of time, as opposed to taxable accounts.
- Tax-free withdrawals: This is basically one of the most attractive features of a 529 plan. All the qualified withdrawals you make from a 529 plan are tax free. This applies for both state and federal income taxes. In simple words, this goes to mean that you don’t have to pay any taxes on the earnings you have gathered to date. Now, keep in mind that this money can only be used for qualified education expenses.
State tax benefits
State deductions or credits: There are several states which are known to offer additional tax benefits for contributing to a 529 plan. It can be any state income tax deductions or credits that can further mitigate your tax burden.
Other factors
Gift tax benefits: In addition to all the above facts, you can contribute up to $17,000 every year per beneficiary to a 529 plan. Why the limit? Well, beyond that, you can include gift tax.
Eligible Expenses for Tax-free Withdrawals
Just as with any other point, it’s important to know the factors that qualify as eligible expenses for a tax-free withdrawal. Read ahead to know in detail:
For Federal Level
Under this, we have the following:
1. Qualified higher education expenses: This can include the ones mentioned below for any accredited college, vocational school, or university that qualified for federal student aid:
- a) Tuition and respective fees
- b) Board and room (this is up to the cost of attendance, as disclosed and described by the school)
- c) The books and supplies necessary for the courses
- d) Special needs equipment and services that are deemed important for enrollment or attendance
- e) For qualified K–12 tuition (private, public, or religious), recipients may receive up to $10,000 annually
- f) The apprenticeship program costs
- g) Up to $10,000 lifetime limit given to every beneficiary for qualified student loan repayments (principal and interest)
For State Level
Under this, we have the following:
2. There are a few handful of states that offer extra benefits for using 529 funds for certain expenses within the state. This includes private K-12 tuition or any other specific program.
How to maximize tax benefits?
Now that you know what a 529 plan is and what are its many tax benefits, it’s now time to understand how to maximize these benefits over time. Here’s how to do it:
Contributing the maximum allowed amount
- Start as early as possible: The power of compounding is what actually makes early contributions more impactful in the long run. Small but regular contributions can add up substantially over time.
- Start to maximize annual contributions: You must check your state’s specific limit, which often surpasses $300,000 per beneficiary.
- Look into catch-up contributions: There are certain states that permit going over the annual cap in specific years (such as rollovers from other retirement accounts).
- Family gifting: Grandparents or other relatives can further help boost the account value by contributing.
Understanding Contribution Limits and Gift Tax Implications
- Annual gift tax exclusion: As per the data for 2024, it is $18,000 per donor, per beneficiary. In this case, couples can usually combine. This makes the amount $36,000 for joint contributions without having to raise eyebrows about gift tax reporting.
- Superfunding or frontloading: By leveraging the annual exclusion, you can contribute almost 5 whole years’ worth in just one ($90,000 for individuals, $180,000 for couples as per the data of 2024).
- Pay attention to the effects of your state’s income tax on contributions: Using an out-of-state plan may prevent your contributions from being deductible.
Utilizing State-specific Tax Incentives
- Start researching the 529 plan of your state: This is where you need to explore and be mindful of the tax deductions, credits, and other benefits that come along with it.
- Compare in-state and out-of-state plans: You should always have a clear understanding of what you are availing. Precisely, start to weigh the tax benefits against the investment options, fees, and college plans
Maximize your tax benefits with the help of expert advice!
Our tax planners are waiting for your call.
Statewise 529 Plan Tax Benefits
Read below some of the tax benefits specific to the states:
Florida 529 plan tax benefits
- The contributions that qualify for the annual gift tax exclusion include $18,000 for single filers, while $36,000 for couples who are filing jointly.
- The plan enables a five-year gift tax averaging for the contributions that go beyond this exclusion. More so, this feature enables an individual to contribute up to $90,000 and a couple up to $180,000 once, without incurring any gift taxes.
- The best part is that this allows for a tax-deferred growth of earnings.
- The withdrawals that are used for K-12 tuition and eligible higher education costs are actually free from the federal taxes.
- In the event that any distributions fail to satisfy the qualifying expense requirements, the earnings portion of those distributions will be subject to a 10% federal penalty in addition to being taxed at the beneficiary’s tax rate.
Arizona 529 plan tax benefits
- The AZ529 plan earnings can gradually grow tax-free without any federal income taxes on withdrawals. This holds true for qualified education expenses, such as books, tuition, room and board.
- The State of Arizona, alongside the mentioned few, also grants a tax deduction if you are investing in an A529 plan. This can be a maximum of $4,000 for married couples, and $2,000 for single filers.
- You are free to choose from several investment options, from mutual funds to FDIC-insured CDs.
Minnesota 529 plan tax benefits
- The residents of Minnesota can subtract up to $3,000 every year (which is, $1,500 for individuals) of contributions that have been made to any state’s 529 plan, including the Minnesota College Savings Plan (MCSP).
- Minnesota also provides a 50% credit on contributions that are made to any 529 plan. This is up to $500 every year.
- Married filers filing jointly with an AGI over $156,680 and single filers with an AGI over $78,340 will see the phase-out of this credit.
Kentucky (KY) 529 tax benefits
- Your savings will actually grow much quicker than anticipated since they are fully tax-deferred.
- Moreover, you can go in anytime and choose to withdraw your money tax-free for qualified educational expenses.
- In addition to all of that, you have gift and estate tax advantages as well.
- The state does not deduct your savings from need-based student aid.
Wyoming 529 tax benefits
The only state without a state-sponsored 529 plan is Wyoming. But, here’s the thing, it does provide a 529A Able Plan. If you are a resident of Wyoming, don’t worry, you still have options to save for college.
Idaho 529 tax benefits
To compute the Idaho taxable income, contributions to the Idaho 529 plan is up to $6,000 every year by single filers, while it is up to $12,000 every year by married couples who are filing jointly. In addition, a 20% state tax credit is available to Idaho employers who make direct contributions to their workers’ IDeal accounts.
Case Studies and Examples of 529 Plans
To understand the advantages of 529 plan tax benefits, let’s look at a detailed case study:
Case Study: The Millers Family with Children Aged between 3 to 5
This family has two very young children, aged between 3 and 5. For them, this is the start of saving for their college education.
Therefore, they have a strategy in mind. The Millers start contributing $3,000 every year to the MCSP account for each child, helping maximize the state tax deduction / subtraction. As time goes by, they receive $250 back from the state for each child when they file an annual claim for the 50% nonrefundable income tax credit.
The benefits they receive are boundless. Since they started early, they could leverage the compounding interest and a tax-free growth. In fact, they saved on the state income taxes through deductions and credits. After a decade passed, considering a 7% annual return, each child’s account almost had an amount of $44,000, alongside substantial tax savings.
To understand your benefits and plans ahead of time, it is best to consult with a professional who knows their way around a 529 plan account.
Want 529 tax plan benefits advice?
Why not consult our expert tax planners!
Bonus points:
- Always remember that in order to keep the tax benefit intact, the contributions must be used for qualified educational expenses.
- When choosing the 529 plan, consider the beneficiary’s college plans. This is because the investment options and fees can largely vary. For these reasons alone, it is best to consult a professional.
- Make sure to explore any other extra resources, such as your state’s 529 plan website, to understand your investment choices better.
In summing up
To be precise, 529 plans are one of the most adaptable and tax-efficient ways to think about educational savings later in life. Not to mention, there are significant benefits that come with 529 plans that help ease the financial hurdle of tuition and other educational expenses.
From maximizing early contributions to using the plans strategically for both short-term and long-term educational goals, the versatility and tax advantages of 529 plans indeed make them a useful tool. In fact, it comes as a savior for future educational expenses that can gradually climb due to inflation.
Still have unanswered questions about how to make the most of your 529 plan? Let our in-house experts be your guide. With more than 12 years of experience in addressing situations like these, we can equip you with the necessary knowledge and information regarding the plans you can leverage for tax benefits.
