What You Didn’t Know About 529 Plans

The cost of higher education continues to rise each year, making it challenging for families to manage this financial burden. Fortunately, all states as well as a consortium of private institutions offer education plans to enable families to save for higher education on a tax-advantaged basis. Even though these plans have been around for nearly two decades, there continues to be confusion about some issues. Here are answers to some questions we received from readers about 529 plans.

What boundaries apply?

In determining whether you are limited to investing within a particular state, first understand whether you are using a prepaid tuition plan or a savings plan; both are 529 plans.

• Prepaid tuition plan. In this plan, you prefund the cost of tuition at a public college or university within your state. If your child goes to a private school or out of state, you receive what you’ve paid for, which will likely cover only part of the tuition at your child’s school. Note: If you are using the 529 tuition plan created by private institutions, your state of residence is irrelevant; your child can prepay tuition at any of the more than 270 private colleges and universities within the consortium (see https://www.privatecollege529.com/OFI529).
• Savings plan. With this option, you have available what you contributed plus the earnings on it (which may vary depending on the success of your investments). There are usually no boundaries for selecting a plan; state residency is not required. For example, if you are in New York, you can use a plan from California (even if your child eventually goes to a school in Illinois). However, the choice of a plan may be impacted by tax incentives (discussed below).

There are no restrictions on having accounts in multiple states. In fact, technically there is no requirement that states count plans in other states when applying their contribution limits.

How can contributions be made?

Contributions must be made in cash. Contributions in property, such as stock, are not permissible.

Who can make contributions?

Contributors to 529 plans are not limited to parents. Anyone, such as a great grandparent, can set up and make contributions. A beneficiary can have multiple 529 plans (e.g., one set up by parents and another by grandparents).

Because there is no age limit for accumulating funds within the plan, an individual can set up a plan for him/herself. Thus, someone who is working and anticipates going to graduate school could squirrel money into a 529 plan for personal use.

What are the tax breaks for making contributions?

There is no federal income tax deduction or credit for making contributions. However, a number of states offer tax incentives for contributing to their plans by residents.

While there is no federal tax break for putting money into the plan, earnings are tax deferred. Withdrawals to pay for qualified education costs are tax free. Thus, if the plan is fully tapped out to pay for the beneficiary’s college tuition, the earnings are never taxed.

How does the 529 impact financial aid?

Assets in a 529 plan are assessed at a rate of 5.64% (the parental contribution rate) in determining a student’s expected family contribution (EFC). Thus, eligibility is decreased by no more than 5.64% of the value of assets in the plan.

Conclusion

529 plans offer considerable tax and financial advantages in saving for college. But be sure to understand the rules and select the best plan for your objectives.