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529 Plans: How to Plan for Education Investment

529 Plans: How to Plan for Education Investment

| November 28, 2023

Education costs have been rising for decades. Families must contend with the high price of college, often taking out student loans that can endanger their children’s financial futures. However, a unique investment option can help them save for college as their funds grow tax-free: the 529 plan.

529 plans offer funds similar to tax-advantaged Roth IRAs. Contributions are made after taxes, and withdrawals after maturity are tax-free. The major difference is that 529 plans are specifically and exclusively for educational expenses.

Since the inception of 529 plans in 1996, most families have enrolled in them to pay for college expenses. But in 2017, the Tax Cuts and Jobs Act expanded the usability of 529 plan funds to allow for certain K–12 educational expenses.

What are some of the advantages of using a 529 plan to fund education, and how can you put one to use for your family?

How Do 529 Plans Work?

529 plans were named after Section 529 of the IRS tax code, where they’re labeled “Qualified Tuition Programs.” They’re available in all 50 states and the District of Columbia, with some states offering their own incentives to invest in them.

Anyone can take part in a 529 plan. Historically, they’ve been opened by parents or grandparents to fund higher education for their children or grandchildren.

Families handle 529 plans the same way investors fund Roth IRAs. The principal amount and subsequent contributions are all made after taxes have been deducted from the principal’s earnings. 

Since the tax liability has already been assessed, contributions to 529 funds don’t incur additional tax charges. Even better, investment gains in a 529 fund are also tax-deferred, allowing for consistent growth with no tax implications.

Although they’re federal programs, 529 plans may also be further incentivized by state policies. Many states allow residents to deduct a significant amount of their 529 plan contributions from their taxable income or offer tax credits for such contributions.

How Are 529 Plans Set Up?

Anyone can start or contribute to a 529 plan. The account owner retains responsibility for investment decisions within the plan, but any party, including family or friends, can donate to the fund.

There are two basic setups for 529 plans. The one most families use treats the 529 like a straight-up savings account. This allows for savings for educational expenses like tuition, textbooks, supplies, and, in some cases, housing costs. Savings plans also present the possibility of higher returns on investments. 

Some states also offer 529 funds as prepaid tuition plans. In this setup, contributors pay for the beneficiary’s future tuition at current rates. That means if a certain college’s tuition rates increase in the future, the beneficiary will still be enrolled at the rates that were in place when the plan was started.

What Are the Limits and Tax Implications of a 529 Plan?

Unlike other investment plans, there are no federally imposed limits on how much you can contribute to a 529 plan. There are some considerations, however, in which contributions may impact tax liability.

Most commonly, if a contribution to a 529 exceeds annual gift tax exclusion limits, the sum counts against the contributor’s lifetime exemption from estate and gift taxes. In 2023, the annual gift tax exclusion limit is $17,000.

States impose overall limits for 529 plan contributions, usually in line with the state’s fiscal ability to maintain such programs. These aggregate limits range from $235,500 to $550,000.

What Expenses Can Funds From a 529 Plan Cover?

The IRS is primarily responsible for deciding what educational expenses can be addressed via 529 plans, although certain states and institutions may provide additional guidelines. In general, however, the funds can go toward expenses like:

  • Tuition
  • Application fees
  • Textbooks
  • Supplies
  • Computers and software
  • Housing
  • Meal plans

In some places, 529 plans can also cover certain K–12 expenses in the beneficiary’s pre-college years. They can cover tuition at private or religious schools, tutoring, books, and supplies, as well as services for those with special needs.

There are more limits when it comes to K–12 funding in 529 plans, so it’s important to know what they are before you start contributing.

Where to Start With a 529 Plan

We’ve provided a brief overview of the basics of 529 plans and how they can impact students’ education paths. There are many more facets, advantages, and potential drawbacks in 529 plan investing, so it’s vital to have a qualified financial adviser to guide you.

Contact Good Life Morehead City to find out more about what 529 plan might be best for your beneficiary.