What is a 529 Plan?
A 529 Plan is an education savings plan designed to help families set aside funds for future college costs. Named after Section 529 of the Internal Revenue Code, these plans are sponsored by states, state agencies, or educational institutions. They come in two main types:
- Savings Plans: Function much like a 401(K) or IRA by investing your contributions in mutual funds or similar investments. The plan will offer you several investment options from which you can select.
- Prepaid Tuition Plans: Allow for the pre-purchase of tuition based on today’s rates and then paid out at the future rate when the beneficiary is in college.
Benefits of a 529 Plan
The earnings in a 529 Plan grow deferred from federal and, in most cases, state income taxes. Additionally, withdrawals used for qualified education expenses are federally tax-free. Some states also offer tax deductions or credits for contributions.
Flexibility and Control
The donor maintains control of the account, and the beneficiary has no legal rights to the funds. You can also change the beneficiary to another family member without tax consequences.
High Contribution Limits
529 Plans typically have high contribution limits, often more than $200,000, accommodating a significant savings allowance.
While primarily meant for college expenses, you can also use the 529 Plan for K-12 tuition and expenses related to apprenticeship programs. Recent laws even allow the usage of funds to repay student loans.
Points to Consider
The investment options in a 529 Plan might be limited, and it’s crucial to assess whether they align with your financial goals and risk tolerance.
Non-qualified withdrawals are subject to income tax and a 10% penalty on earnings, making it essential to plan the usage of funds meticulously.
Impact on Financial Aid
While a 529 Plan has a minimal effect on federal financial aid eligibility, it can still impact the financial aid package, and it’s vital to consider this aspect when planning.
The biggest downside to 529 plans is about to go away. Now they’re a ‘no-brainer,’ expert says. You can now transfer up to 35k of unused funds into a Roth IRA.