Client Question: 529 Plans

February 2, 2023

I’ve talked with a few clients in recent weeks about various aspects of 529 plans. These can serve as powerful savings vehicles for an important expense, so I thought a refresher may be helpfu.

What is a 529 plan?

A 529 plan is a state-sponsored program that allows parents, relatives and friends to invest in a child’s (or any person’s) K-12 and college education. Almost all states and the District of Columbia offer some type of 529 plan. However, you don’t have to live in a particular state to take advantage of its plan. (Note: 529 refers to the tax code which derived this account and its related benefits)

How do you decide which 529 plan to use?

There are many articles and reviews of the various 529 plans online. Most people choose to use the one offered by their state of residence as there is often a state tax deduction. Others may choose the one that is affiliated with their broker-dealer of choice (like Schwab, Vanguard, etc). If you are considering setting up a 529 plan, take the time to research your options carefully.

What are its benefits?

Earnings in a 529 plan grow federally tax-deferred, which means your money has a chance to compound faster because you don’t have to pay taxes on current investment income or capital gains. Even better, withdrawals are tax-free as long as you use the money to pay for qualified education expenses, which typically include tuition, books, school supplies and room and board.

How should I set up the account?

Typically it is best to have the adult (parent, grandparent, etc) be the owner of the account and make the child/future student the beneficiary. This allows the adult to control the account and possibly reassign the funds to a new beneficiary in the future (see below)

When should I set up the account?

As noted above, the funds in these accounts grow tax-deferred and the withdrawals are also tax free when you withdrawn them for qualified education expenses. As a result, the accounts are the most powerful when you fund them “early and often” during a child’s life as it gives the funds a longer time frame to grow.

Are there contribution limits?

There are not direct limits on 529 plans but they are considered gifts (see above discussion of owner/beneficiary). Many choose to stay below the gift tax exemption level ($17,000 per person in 2023). There are ways to group your gift into one year and aggregate limits that vary by state. As always, it’s best to work with your financial advisor and specific plan before funding these accounts

What are the underlying investments?

The investment options will vary by plan/state. Most 529 college savings plans allow for a variety of investments, which may include index options, active management options, age-based portfolio, and others. Review the details on each investment and decide what works best in your situation

What if my child doesn’t use it?

529 funds need to be used for qualified education expenses. If your child doesn’t use the funds, you can change the beneficiary (to another child, yourself, your spouse, etc) – or even consider saving it for your child’s future education or save it for a future grandchild. There are also special rules that allow for penalty free withdrawals to take into account scholarships and to repay student loan balances. If you exhaust all other options, you can withdraw the funds and you will pay a 10% penalty and income tax on the earnings (not the original contributions).

As always, please consult your financial and tax advisor for assistance putting these plans to work for you and your family.

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