Qualified Tuition Plans and 529 College Savings PlansSubmitted by MIRUS Financial Partners on April 19th, 2022
The United States Congress created the 529 plan in 1996 and has been modifying it ever since. Like many government tax-advantaged products and programs, this plan gets its name from its placement within the Internal Revenue Service code (Section 529). 529s are also called "qualified tuition programs" or QTPs.
Save for Your Children's Education and Save on Taxes
529 savings plans have many features and benefits, but the most appealing is the federal tax advantage. Contributions to a 529 account are tax-free if the money is used to pay the beneficiary's qualified education expenses. If funds are not used for qualified education expenses, they are treated in the same way unqualified withdrawals from retirement plans are treated–they are taxed and subject to a ten percent penalty.
Each state decides the associated tax advantages. States are free to offer their own tax benefits, such as a tax deduction for contributions, to state residents and these benefits vary by state.
529s also have very high contribution limits, usually $350,000 and up, but restrictions vary by state. And anyone can open a 529 savings plan account, regardless of income level.
However, money in a 529 savings plan must be used for educational purposes. In addition to covering tuition and fees, 529 savings can also go toward room, board, books, and school supplies at any accredited college or graduate school in the United States or abroad.
The savings plans can also be used to cover costs for certified apprenticeship programs, including fees, supplies, and equipment. Each beneficiary of the plan can use the money to repay student loans up to $10,000 and $10,000 per each of the beneficiary's siblings. 529 funds can also be used to cover K-12 tuition up to $10,000 per year.
The plans offer some flexibility. The beneficiary can be changed to another qualified family member, or funds can be rolled over or transferred into a different 529 plan, one time each calendar year. Violations in the policy will result in the need to pay income tax and/or penalties.
Use 529s as Part of an Estate Plan
A 529 savings plan can be used as part of a smart estate plan. Grandparents can contribute to a 529 to fund their grandchildren's educations while reducing the size of their taxable income. Limits and tax deductions change each year, so check with the IRS or a tax expert for current contribution limits and conditions.
Transfer the Funds to an ABLE Account Without Penalty
ABLE accounts are tax-advantaged funds that provide savings for disability-related expenses for individuals who become blind or disabled before age 26.
The 529 account allows owners to roll over or transfer funds to an ABLE account without paying federal taxes or penalties.
More Than 50 State 529 Savings Plans
Although most aspects of the 529 savings plans are governed by federal law, individual states manage the implementation. As a result, there are now more than 50 different savings plans from which to choose.
Residency is not a requirement to join any state's 529 savings plan, but each state and each plan has created its own rules and guidelines. To make things more complicated, those rules can change at any time. While most states offer an income tax break, those tax breaks vary considerably among plans. Fees and expenses also range, including annual maintenance fees, administration and management fees, and underlying fund expenses.
The investment options also vary from plan to plan. When evaluating 529 plans, make sure you can choose from a range of investment options, including conservative and growth-oriented funds. Like with 401(k)s, you want to balance risk with the time frame of your savings. Most plans offer age-based portfolios. These will shift your investments to more conservative holdings as your child approaches college age. Like with retirement funds, investments in your 529 are a risk, and past performance is no guarantee of how an investment will perform in the future. The investments you choose may lose money or not perform well enough to cover college costs.
How it Works
Once you've set up the plan, most allow participants to contribute as often as they like. You can tailor your contributions based on your needs and budget. You can also use an auto-pay feature or set up automatic monthly transfers from your online bank account.
Like 401(k)s, there is a limit to the number of times you can change or adjust your existing investments. However, changes for future contributions are regulated differently and can be changed at any time.
Savings vs. Prepaid Tuition
A 529 plan can be either a savings plan or a prepaid tuition plan. Both offer the same tax benefits, but the prepaid tuition plan requires you to prepay tuition at participating colleges at current levels or prices. These plans are usually limited to state residents. The 529 savings plans can be used for tuition in any state, for technical schools, and by residents of any state.
Get More Information
Because there are so many plans in so many states available, you may want an experienced financial professional to help you select a plan and associated investments. Some 529 savings plans are advisor-sold only, meaning you must go through a designated financial advisor to open an account. We can help. Contact us at MIRUS Financial Partners if you want to explore your 529 options for your family.