529 College Savings Plan

The 529 College Savings Plan is a valuable tool for families looking to save for college expenses, offering a range of benefits and considerations.It is a tax-advantaged investment plan that allows almost any adult—a parent, guardian, grandparent, aunt, uncle, or even a friend—to help pay for someone’s education, regardless of income level. You can even open a 529 plan for yourself. Most 529 plans offer a wide range of investment choices allowing you to invest your assets in the portfolio(s) that best suit your education savings goals.

Much like a ROTH IRA, earnings grow federal income tax-free, and earnings are free from federal income tax when withdrawn to pay for qualified education expenses at most accredited two- and four-year colleges and universities and vocational-technical schools anywhere in the U.S. along with many outside the U.S. Savings may even be used for certified apprenticeships. Qualified education expenses include tuition and fees, books, room and board, computers required for the course, and many other expenses. At this time, it is not clear what, if any, expenses will be regarded as “tuition” in the case of public schools.

The funds can also be used for tuition at eligible public, private, and religious K-12 schools, up to $10,000 per year per beneficiary. Additionally, up to $10,000 may be paid toward the principal or interest of a student loan for the beneficiary or a sibling. The money is always owned and controlled by the person who sets up the account, not the beneficiary.It is important to remember that contributions to the 529 plan are never deductible.

Here are some advantages for these plans:

1. Tax Reduction: Participation in a 529 plan often results in a reduction of state income tax.

2. Tax-Advantaged Growth: Contributions to the plan grow without federal taxation.

3. Flexible Contributions: Anyone can contribute to the plan and receive a state tax deduction. Contributions exceeding the gift tax limit ($18,000 for 2024) per account may require a gift tax return.

4. Tax-Free Withdrawals: Withdrawals used for qualified college expenses are tax-free for both the student and parent, provided the account holder is either the parent or student.

5. Family Transfers: Funds in the account can be transferred to other family members for qualified college expenses.

6. Estate Planning: Five years’ worth of gifts (up to $90,000 for an individual or $180,000 if a married couple) can be made at once to a 529 plan without owing federal gift tax, as long as no other gifts are made to the same beneficiary over the five years.

7. State Tax Deduction (for many states, but NOT California). Most states with an income tax allow either a deduction from income or a state tax credit for 529 plan contributions when reporting income for state tax purposes. Most states allow any contributor, not just the account owner, to claim the applicable tax benefits on their tax return. However, not all states follow the federal state treatment of K-12 tuition or student loan expenses.

Here are some disadvantages:

1. Tax Penalties: Withdrawals not used for qualified education expenses incur a 10% tax penalty on earnings, with earnings becoming taxable. However, changing the beneficiary to another family member can avoid this penalty.

2. Lack of Guarantee: The account’s performance is not guaranteed.

3. Financial Aid Considerations: The account is considered part of the parent’s assets when applying for financial aid.

4. State Requirements: Some states may impose a minimum holding period to receive state tax benefits.

Before investing in a 529 College Savings Plan, it’s important to thoroughly research the specific plan, including its fees and expenses. Additionally, consider that certain states offer tax benefits and fee savings exclusively to residents.

For personalized tax advice, consult a tax professional. Remember that non-qualifying distribution earnings are taxable and subject to a 10% tax penalty. Investors should carefully review the investment objectives, risks, charges, and expenses associated with 529 plans before investing.

Detailed information about 529 plans can be found in each issuer’s official statement, which should be reviewed carefully before making any investment decisions.

Additionally, investigate whether your state offers a 529 plan with favorable state tax benefits for residents.