529 College Savings Plans: The Comprehensive Guide

529 College Savings Plans: The Comprehensive Guide

College is one of the largest expenses that parents encounter. Fortunately, parents have 18 years to save for this daunting financial goal. Many turn to 529 college savings plans, which allow them to save for college in a tax-advantaged way, but the rules and regulations are often confusing and intimidating. In this post, we’ll address common questions about 529s and how they can be used for college savings.

What are 529s used for?

529s are a convenient and tax-advantaged way to save for your child’s education. Through investing in stocks and bonds, 529s provide a great way to prepare for the expenses of college, such as tuition, room and board, and textbooks. As long as the withdrawals are used for these qualified educational expenses, they are exempt from federal income tax. For those looking for an easy and beneficial way to save for their child’s college education, 529s should be strongly considered.

How does the state affiliation of a 529 plan impact the way I use it?

You can use a 529 plan from any state to pay for an eligible college in any state. For example, you can use a 529 plan from Ohio to pay for college in Illinois. 

Some states provide special financial aid benefits for students who have a 529 plan in the state, such as not counting the 529 plan as an asset when determining eligibility for state grants and other state aid.

While you can use a 529 plan from any state to pay for an eligible college in any state, you may wish to direct new contributions to the new state’s 529 plan to take advantage of the state income tax breaks on contributions to the state’s 529 plan. You may also wish to invest in a low-fee 529 plan from another state, particularly when the child is young. When the child enters high school, the state income tax deductions and tax credits may then be worth more than the lower fees on an out-of-state 529 plan.

How much will I be able to contribute? 

You and your spouse can make separate gifts of $17,000 to each child ($34,000 per child) in 2023. You can expect these contribution limits to be revised upwards over time.

If the 529 money goes unused, am I able to reassign those assets to another child? 

Yes, you will be able to contribute to one child’s 529, and then reassign that 529 to another child if funds have not been fully utilized.

What are my options if funds go unused and I don’t have another child to reassign those assets to? 

If your child earns a scholarship, you can withdraw the scholarship dollar amount without penalty, although you will be required to pay income tax on the earnings portion of that amount. If you make a non-qualified withdrawal, however, you will not only have to pay income tax on the earnings portion, but also a 10% penalty on the same portion. Additionally, your child has the option to reassign the account to a future child. It’s worth noting that if they choose to pursue higher education at a qualified institution, such as graduate school, medical school, or law school, they can also use these funds.

Should I use the same 529 for multiple children? 

The short answer is: probably not. While it is possible to reassign your 529 between children, there are serious potential downsides to using the same 529 for multiple children. For instance, if your children’s educational expenses overlap, you will have to change the beneficiary on the account multiple times every semester. Furthermore, if you were to pass away unexpectedly, one of your children would be entitled to the entirety of the funds set aside for both children, creating a difficult situation for them to navigate. For these reasons, we recommend making a rough estimate of the amount you’ll need for each child and allocating your 529 contributions accordingly.

How do I choose a 529 plan? 

We prefer to use the cap ratings from Saving For College, a CPA-founded website dedicated to 529 plan research since 1999. With dozens of options spread across the U.S., it helps to use a standardized rating system that evaluates and compares multiple facets of 529 plans. We’re happy to help clients in the 529 plan selection process. 

What is the difference between an advisor-sold plan and a directly sold 529 plan? 

Advisor-sold plans tend to be more expensive than directly-sold plans, especially if the advisor has chosen to use A-shares vs. lower-cost options such as ETFs. 

For this reason, we strongly recommend utilizing directly-sold plans over advisor-sold plans. However, as advisors, we are still able to keep an eye on our clients’ 529 investments by acting as an interested party on the account.

Does it matter which state I purchase a 529 plan from? 

Regardless of which state’s 529 plan you purchase, you will be able to use those dollars within any state. That being said, it is essential to check to see if your state offers an income-tax break for investing in its plan. For states like Texas that don’t assess state income taxes, this is not a concern. 

Can I use 529 funds if my child attends college online? 

Yes, if your child is enrolled in an eligible institution, they can use 529 funds to pay for online education. Eligible universities qualify for Title IV student aid. You can find that list here on the Department of Education’s website. 

Can I use 529 funds if my child attends an international university or for study abroad? 

Yes, as long as your child attends an eligible institution, they can use 529 funds for an international university. To be eligible, the university must be recognized by the U.S. Department of Education’s Federal Student Aid program. You can find that list here on the Department of Education’s website

Can I use 529 funds for grad school/law school/med school? 

Yes, you can use 529 funds for graduate degrees, law degrees, and medical school

Will my child’s choice of education institution affect how much they pay?

College expenses can vary drastically between institutions, with the most expensive topping out around $80,000 once room and board are taken into account. 

Additionally, parents and kids need to weigh the relative benefits of public vs. private institutions as well as in-state vs. out-of-state tuition. 

According to U.S. News, in 2021 in-state public schools cost 74% less than private universities. 

How fast do we expect expenses to grow? 

According to U.S. News, between 2002 and 2022 the average tuition and fees at private universities jumped 134%, out-of-state tuition and fees at public universities rose 141%, and in-state tuition and fees at public universities saw the most significant growth of 175%. That being said, the past increase in the price of education may not be reflective of price increases moving forward, and forecasting the cost of a college education moving forward will prove challenging.

When should I start saving?

The earlier the better! As an example, if you invested $1,000 and made contributions of $100 a month, and those funds compounded at 8% annually over an 18-year period, your total amount at the end of the 18-year period would be $71,670.58. Provided that expenses don’t climb substantially, this is an amount that would cover in-state tuition at most universities across the U.S. 

Will 529s cover room and board? What if I live off-campus?

Yes, 529 plans will cover room and board whether you’re living on campus or off campus. 

Will 529s affect my financial aid/scholarship?

529s don’t impact merit-based scholarships. As mentioned elsewhere, if you do receive a scholarship, you can withdraw that amount without penalty. 

That being said, funds in a 529 plan are considered an asset of the account owner, which means that they may affect financial aid.

The impact of a 529 plan on financial aid depends on who owns the plan. If the plan is owned by a parent or dependent student, it is considered a parental asset on the Free Application for Federal Student Aid (FAFSA). This means that up to 5.64% of the value of the plan will be factored into the Expected Family Contribution (EFC), which is used to determine financial aid eligibility.

However, if the plan is owned by a grandparent or other relative, it is not reported as an asset on the FAFSA. Instead, withdrawals from the plan are reported as untaxed income to the beneficiary (the student), which can reduce financial aid eligibility by up to 50% of the withdrawal amount. This is not the case for 529 accounts owned by the parent or student.

How much will a 529 grow?

529 growth will be determined by a variety of factors, including the number of years you contribute, your savings amount, the performance of the market, and the investment choices your 529 is allocated towards. 

Can 529s be a bad idea? When might a 529 plan not be advisable?

529 plans are not a good option for individuals who don’t want to be locked into using the money for educational expenses. If the money is used for something other than qualified educational expenses, it will be subject to a 10% tax penalty. For individuals with other financial goals, such as retirement, investing in an IRA or 401(k) may be a better option than a 529 plan.

Are 529 distributions taxable? 

Provided you are spending the funds on qualified expenses your 529 distributions will not be taxable. 

Can a 529 be used for private K-12 expenses? 

Yes, a 529 plan can be used for K-12 private school tuition. Each state has different rules regarding how and whether these funds can be used for a private school, so it’s important to check with your state’s 529 plan rules to know what is a qualified expense for that specific plan. 

Who can contribute to a 529 plan? 

Anyone can open and contribute to a 529 plan including parents, grandparents, friends, and family members of the beneficiary. 

Note that anyone who contributes to a 529 plan should be aware of the gift tax implications. Generally, a 529 plan contribution is treated as a gift for federal tax purposes. This means that any single person can give up to $15,000 per year to each beneficiary without incurring any gift tax. Contributions over $15,000 may be subject to federal gift tax, depending on the donor’s other gifts that year.

Can I use a 529 plan to pay my student loans?

Student loans are unfortunately not considered a qualified expense for a 529 plan, so funds from a 529 plan cannot be used to pay student loans.

What is the total contribution limit for a 529?

Aggregate 529 plan contribution limits are set by each state for the plan they administer (e.g. California for the TIAA ScholarShare plan). These limits reflect an estimate of the cost of attending an expensive 4-year college and graduate school in that state. 

Can I roll over a 529 plan?

Until December 23rd, 2022, the answer to this question was a resounding no. However, new rules included in an omnibus spending package allow for up to $35,000 to be rolled over from any 529 accounts to a Roth IRA account in the beneficiary’s name over the course of their lifetime, starting in 2024. 

The contribution limit for 2024 is scheduled to be $6,500, plus an extra $1,000 for those over 50, with the catch-up limit allowance. The account must have existed for 15 years and any contributions or earnings from the last five years cannot be rolled over. These changes will allow people to save for college without worrying about their child not going and provide tax-free withdrawals.

Are 529s affected by the stock market?

Yes, 529s can be affected by the stock market. The performance of your 529 will depend on the investments that you select. If you choose an age-based portfolio, the underlying investments may be more conservative as your child gets closer to college age. Conversely, investments may be more aggressive when your child is younger. As the investments you’ve chosen fluctuate, the value of your 529 will also fluctuate.

When were 529 plans created? When did they start?

529 plans were created in 1996 when the Taxpayer Relief Act was passed.

What counts as a qualified expense for a 529 plan? 

The funds in the 529 plan can be used to cover qualified education expenses, such as tuition, fees, room and board, and other related expenses. 

Qualified expenses are those that are required for enrollment or attendance at an eligible educational institution. This includes tuition, fees, room and board, books, supplies, equipment, and other related expenses such as transportation. 

In some cases, the plan may also cover certain educational expenses for a beneficiary who is enrolled at least half-time in an eligible post-secondary institution. These expenses may include room and board, computer equipment, internet access, and other related expenses. 

It’s important to note that 529 plans are subject to different rules and regulations depending upon the state the plan is based in. So it’s best to consult a financial advisor to ensure that you fully understand the regulations for your particular plan.

What kinds of college expenses should I budget for?

For parents of college students, the biggest college expenditures are tuition, room and board, books and supplies, transportation, and miscellaneous expenses. Tuition typically makes up 40-50% of college expenses. Followed by room and board (25-30%), books and supplies (10-15%), transportation (10-15%), and miscellaneous expenses (5-10%). 

How should I go about estimating and comparing my child’s cost of university?

  • Research and compare colleges: Researching and comparing colleges can help parents get a better sense of the expected costs at each college.
  • Calculate tuition costs: Parents should calculate the total cost of tuition for the entire college experience, including any additional fees.
  • Estimate room and board costs: Parents should estimate their child’s room and board costs based on the type of housing they plan to live in and their meal plan.
  • Estimate books and supplies costs: Parents should estimate the cost of books and supplies based on their child’s major and course load.
  • Estimate transportation costs: Estimate your child’s transportation costs, including any commuting costs, flights home for breaks, and other travel expenses.
  • Estimate miscellaneous costs: Think about miscellaneous costs, including technology, insurance, and social activities. For some students, these costs will be greater than others depending upon what types of social activities they plan to engage in.
  • Research scholarships and grants: Research scholarships and grants to help offset the cost of college. Also, look into financial aid options, such as loans, to help cover the remaining costs. 
  • Track expenses: Once your child enters college, track their expenses to ensure they stay within their budget. 

Should I use a 529 vs. a UTMA for education expenses?

A UTMA (Uniform Transfer to Minors Act) account is a custodial account that allows you to transfer assets to a child without going through the probate process. With a UTMA account, you can save for a child’s educational expenses, but the funds can also be used for other purposes, such as medical expenses or buying a car. With a UTMA account, the earnings on the funds are not tax-deferred, and contributions to the account are not tax-deductible. However, there are fewer restrictions on how the funds can be used. 

Ultimately, the best option will depend on your individual circumstances. If you’re looking for a tax-advantaged way to save for a child’s educational expenses, a 529 plan may be the best option. However, if you want the flexibility of using the funds for other purposes, such as medical expenses, a UTMA account may be the better choice.

Should I use a 529 vs. Coverdell for education expenses?

Coverdell ESAs are also state-sponsored, tax-advantaged savings accounts that can be used for qualified education expenses. Unlike 529 plans, Coverdell contributions are deductible on your federal tax return up to certain limits, and the earnings are tax-free if used for qualified educational expenses. However, Coverdell ESAs have more restrictions than 529 plans; contributions are limited to $2,000 per beneficiary each year, and the beneficiary must be under the age of 18.

What about scholarships? 

Scholarships can be a great way to help finance your child’s college education, and it’s important to research the different types available. Merit-based, need-based, and athletic scholarships all have their own eligibility criteria and application requirements, so it’s important to be aware of the deadlines associated with each and the amount of money typically provided. Some scholarships may have additional requirements for receiving and maintaining the scholarship, so be sure to read the fine print. The components above are great starting points to begin thinking about saving for college. We do detailed financial planning for clients who are looking to save for their children’s education planning. If you’d like to discuss this further, feel free to send me an email at [email protected].

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