What is a 529 Plan?
What are the tax benefits of a 529 plan?
A 529 plan is a powerful tool that should not be overlooked by any parent planning to send their kids to college one day. A 529 plan allows you to invest money in stocks, bonds, ETFs, and similar investments so that the money can grow by the time the child is ready to use it for college. The benefit of using a 529 plan over a regular brokerage account for this purpose is that the money grows tax-free, as long as it is withdrawn and used for qualified educational expenses. Depending on the state that you live in, you may also get a tax deduction or credit for each contribution that you make.
Who can open a 529 plan?
One of the biggest advantages of a 529 plan is that just about anybody can open them. Parents, grandparents, relatives, and even friends can open a 529 plan to contribute money for a student. The person who opens the account will control how much they contribute and also decide how the money is invested.
What investments can you hold in a 529 plan?
The investments that you can hold in a 529 plan are much the same as what you would hold in a 401K, IRA, or taxable brokerage account. This would include assets such as stocks, bonds, ETFs, and mutual funds. Many providers also provide tailor-made target date funds in these 529 plans. Similar to a target date retirement fund, these plans will start more aggressively with a heavier exposure to equities in the early years, and then get more conservative the closer you get to using the money.
What are qualified education expenses?
One of the most important things to understand about 529 plans is that only withdrawals for qualified educational expenses are tax-free. Any withdrawals that are not for qualified educational expenses will be taxed at the normal income tax rates plus an additional penalty of 10%. Thankfully, many different types of expenses qualify. These would include tuition and fees, books and materials, room and board, internet access, and computers. More recently, the IRS has also allowed 529 distributions to be used for K-12 educational expenses of up to $10,000 per year. Lastly, up to $10,000 from a 529 plan can be used to pay off student loans.
What happens if my child decides not to go to school?
One of the main hesitations that many people have with opening a 529 account is the possibility that their child decides not to go to college. Thankfully, there are many excellent alternatives that will still allow you to avoid taxes on the gains in the 529 plan. The first would be to change the beneficiary of the 529 plan to another qualifying family member. Alternatively, you can make yourself the beneficiary of the plan and use the money to further your own education. Another option would be to continue to hold the funds in the account and let them grow in case the child decides to attend college later in the future. Finally, beginning in 2024 up to $35,000 from a 529 plan can be rolled over into a Roth IRA if the plan has been in existence for more than 15 years.
