From tuition payments and academic book purchases to room and board payments, education involves a plethora of variables and expenses. Most states have prepared for this unfortunate shift in education costs and have established 529 savings plans to help families take advantage of tax-saving opportunities all while effectively planning for upcoming education costs.
What is a 529 Education Savings Plan?
According to the Securities and Exchange Commission, SEC for short, a 529 education savings plan is a tax-advantaged savings account set up to encourage planning and saving for higher education costs. 529 plans, legally referred to as “qualified tuition plans,” are sponsored by states, educational organizations, and state agencies. Section 529 of the Internal Revenue Code implemented 529 plans, creating two main types of 529 plans: prepaid tuition plans and education savings plans.
Prepaid Tuition Plans
Prepaid tuition plans allow a saver or account owner to purchase units or credits at academic institutions participating in the program. Usually, at public and in-state universities, prepaid tuition plans save money for future tuition and mandatory fees at current prices for the account’s beneficiary. Prepaid tuition plans are not commonly utilized for future room and board payments and do not allow account owners or beneficiaries to prepay tuition for elementary or secondary schools.
Prepaid tuition plans are commonly sponsored by state governments and include residency requirements for the saver. The federal government does not guarantee state plans, but some state governments do, however, guarantee that money is allocated into the prepaid tuition plan funds. This is particularly important to understand when deciding the future of the account funds for individuals. For example, if prepaid tuition payments are not guaranteed by the government, either federal or state, then you may lose a portion of the money in the plan if the sponsor has financial struggles.
Education Savings Plan
Education savings plan entail opening an investment account to save for a beneficiary’s future in qualified higher education. This account can be used to cover tuition, mandatory fees, and room and board expenses. Withdrawals from an education’s savings plan account can likely be used at any college or university, oftentimes including non-U.S. academic institutions.
You can also use your 529 plan to pay for K-12 tuition up to $10,000 per year per beneficiary. For example, withdrawals for K-12 expenses may not be exempt from state tax in certain states. If you are using the account for elementary or secondary school tuition payments, the investment portfolio selected for the account has a shorter time horizon for the investments to grow. However, investment portfolio options directed at K-12 tuition include a variety of mutual fund and exchange-traded fund portfolios.
State governments sponsor all savings plans, but very few have residency requirements. You should research multiple states’ 529 education savings plans to find the best fit for your situation. The investments in an education savings plan are not guaranteed.
Tax Advantages
Utilizing a 529 education savings plan can not only help prepare a beneficiary for future education but can also provide you with tax benefits. State tax benefits vary, but there are federal tax advantages that are universal to 529 savings plans.
Many states offer tax deductions for contributions made into 529 education savings plans but may include various requirements or restrictions. You may only be entitled to state tax deductions for contributions if you are a resident of the state the education plan originates from.
In addition, you can even use 529 plans to pay for certain student loan expenses, including the loans of a beneficiary’s sibling, up to a $10,000 lifetime maximum. This can be beneficial when student loan obligations become overwhelming. Understanding the limitations surrounding this situation will be critical, making contacting an advisor helpful.
Withdrawing from 529 savings plans can also provide tax benefits. Withdrawals from 529 education savings plans, including any gains, are not subject to federal and state income tax. If withdrawals from the account are not used for qualified education expenses, however, the withdrawal will be subject to state and federal income tax and an additional 10% federal penalty tax on earnings.
Summary
529 education savings plan can be a great way to allow your investments to grow tax-free while enjoying tax breaks from federal and state governments. High net-worth individuals can utilize these plan options to minimize their tax burden while ensuring their beneficiaries are able to obtain a higher education. For more information, reach out to BLU financial Planning.
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