• Kyle Johnston

529 Plans

Updated: Dec 29, 2020

Save and invest in a tax-advantaged manner.



529 plans are tax-advantaged savings plans that are dedicated to future education-related expenses. By saving and investing for college through a 529 plan, benefits can be realized by both the plan beneficiary and the plan owner. Below we will dive into plan specifics, strategies, and benefits.


Savers have two options when it comes to 529 plans: 529 savings plans and 529 prepaid tuition plans. 529 savings plans provide the opportunity for tax-deferred growth on funds that can later be used for qualified education expenses such as college tuition. Prepaid tuition plans allow you to pay in advance for tuition at designated colleges in order to lock in today's tuition rates. 529 savings plans are the more flexible of the two and the most common. Plans are typically set up by a parent or grandparent on behalf of a child or grandchild, but they can be opened by just about any U.S. citizen that is over 18 years of age and wishes to give the gift of education. 529 plans can even be set up by students themselves if, for instance, the student is saving for grad school and wishes to take advantage of any tax benefits provided by the plan. Plans are offered by every U.S. State but you are not restricted to the plan provided by the state in which you live (more on this later).


Benefits of 529 savings plans:


-Contributions may be eligible for state tax incentives in over 30 states. In most states, you must invest in your home state's plan in order to realize the benefits. However, 7 states, including Pennsylvania and Minnesota, offer incentives for contributions to any 529 plan in the country. Because tax incentives differ state to state, it is important to research the benefits provided by your state before choosing a plan. In Massachusetts for example, contributions of up to $2,000 are state income tax deductible for married couples filing jointly (up $1,000 for single filers).


-Funds contributed to the plan can then be invested in various investment options and grow tax exempt until usage. Options can be risk-based or time-based. Risk-based investments offer a relatively static asset allocation mix for varying levels of risk. Time-based investments operate in a similar manner to target-date funds; the asset allocation mix is based on the number of years until the beneficiary is expected to enroll in college and shifts from more risky allocations during the early years of the plan to more conservatives allocations as the expected enrollment date approaches.


-The selected investment option can be changed twice per year or in the case that the plan beneficiary has been changed.


-When the time comes to use the savings, withdrawals that cover eligible expenses are tax-free. Eligible expenses include college tuition, room & board, textbooks, and have recently been expanded to included k-12 education, registered apprenticeship programs, and up to $10,000 in student loan debt repayment for account beneficiaries and their siblings.


-Plans can also be quite flexible if the original beneficiary does not attend college or receives a large scholarship. In cases where the original beneficiary can't or does not need to use the funds, the beneficiary can be changed to an immediate family member (cousin, sibling, etc.) of the original beneficiary without penalty. Excess/unneeded funds can easily be transferred to a new beneficiary.


-Multiple plans can be opened for the same beneficiary if, for instance, the parents and grandparents both want to open plans and realize the potential benefits that come with contributing. Tax benefits may vary as in some states, the maximum contribution that is eligible for tax incentives is on a per beneficiary basis, while in others it is on a per tax payer basis.


-529 savings plans can also be an effective estate planning tool. The assets in the plan remain in the control of whoever owns the plan but the value of the assets is removed from that individual's taxable estate. In a sense, contributing to a 529 plan can be like gifting money without losing control.


Other considerations:


-It is important to assess your state's 529 plan options by examining the associated fees (investment, application, administration, and program management), investment options, and tax benefits. State tax incentives should be weighed against the fees and investment options of your home state's plan. If your state's plan has high fees and limited/expensive investment options, it may be worth considering the plans of other states and foregoing the state tax incentives.


-Pay attention to the list of qualified expenses and your state's rules in order to avoid any penalties. One tip is to pay the college/university directly from the plan in order to avoid any mismatch between withdrawals and qualified expenses that could trigger a penalty.


-529 plans may impact the beneficiary's financial aid eligibility. The degree of impact depends on who the owner of the plan is. In general, 529 plans that are owned by the student's parents have the least impact on eligibility.


-Some states have 529 plan annual contribution limits, though they tend to be very high and in the $200,000 to $500,000 range.


-If a 529 plan goes unused, can't be transferred to a new beneficiary, and the funds need to be withdrawn, only the portion of the funds attributable to investment earnings can be subject to income taxes and penalties. If a withdrawal is made and not used to pay a qualified expense, the earnings portion of the withdrawal may be subject to a 10% fee and income taxes. Under certain circumstances, withdrawals may be subject to taxes, but free of penalties. These circumstances include the following: the beneficiary has received a tax-free scholarship, the beneficiary attends a U.S. Military Academy, the beneficiary has received education assistance the a qualifying employer program, or the beneficiary has passed away. While a fee and taxes may be levied on unqualified withdrawals, the funds will still have grown tax deferred and the end result may not be much different than if you had simply invested in a taxable investment account.


By taking advantage of a 529 plan early, you will be on the right path to efficiently saving and investing for your beneficiary's future education expenses. More information can be found at the following helpful sources: SavingForCollege.com, Massachusetts 529 Plans at Fidelity, Morningstar Top 529 Plan Rankings. When in doubt, don't hesitate to reach out to us at 1620 Investment Advisors!