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529 plan benefits

With tuition increasing at a steady pace and student loan debt reaching record highs, many parents struggle finding ways to lower the price of higher education. But a 529 college savings plan can help. These tax-friendly savings vehicles offer a range of perks. Below, we explore 529 plan benefits in detail. But first, we’ll explain exactly what they are.

What Are 529 Plans?

529 college savings plans are designed to help you save up to pay college expenses like tuition and mandatory educational expenses. Direct 529 plans function much like 401(k) accounts. You simply contribute toward a professionally managed investment portfolio.

Some of these investment plans feature the guidance of a financial advisor. This professional can help you create a unique savings strategy based on your financial situation to make the most out of 529 plan benefits. In addition, a 529 prepaid tuition plan allows you to lock in current tuition prices and essentially purchase them in advance.

529 plan benefits abound no matter which type of plan you choose. Read on to understand get a full understanding of what 529 plans can do for you.

529 Plans Offer Unmatched Tax Benefits

As you invest in any 529 plan, your earnings grow tax-exempt. Furthermore, you’re allowed to withdraw your money tax-free if you use the funds on qualified education expenses. These include the following:

  • Tution
  • Mandatory fees
  • Books and supplies required to take courses
  • Electronic equipment and Internet access needed for enrollment
  • Room and board that doesn’t exceed published estimated costs of on-campus housing
  • Special needs equipment necessary for attending classes

But the tax benefits don’t stop there.

Most States Offer 529 Plan Tax Breaks

Several states allow you to make tax-deductible contributions or receive tax credits up to certain limits. More than 30 states including the District of Columbia currently offer such perks.

Most states allow above-the-line tax deductions when it comes to 529 plans. This means you deduct the contributions before determining your state taxable income.

Several states also allow you to carry forward excess contributions into the next tax year. So let’s say your state lets you deduct contributions up to $5,000 with a two-year carry forward. You contribute $7,000 one year. As a result, you can claim only $5,000 as a state tax deduction for that tax year. However, you can factor the difference or $2,000 into tax-deductible contributions for the next two years even if you didn’t make any contributions in that time frame.

The table below illustrates which states allow tax-deductible contributions and to what extent. Each deduction or limit for a credit listed below reflects what married joint filers can claim. Single filers may claim half the amount unless otherwise stated.

529 Plan State Tax Benefits
  State 529 Deduction/Credit
 Alabama  $10,000
Arizona  $4,000
 Arkansas  $10,000
 Colorado  Entire contribution amount
 Connecticut  $10,000 with 5-year carry forward of excess contributions
 Georgia  $2,000 per beneficiary
Iadaho  $8,000
 Illinois  $20,000
 Indiana  20% tax credit on contributions up to $5,000
Iowa $6,326 per account
Kansas $6,000 above the line exclusion from income per beneficiary, regardless of which state’s plan you enroll in
Louisiana $4,800 above the line exclusion from income, with unlimited carry forward of excess deductions
Maine $250 per beneficiary
Maryland $2,500 per account, per beneficiary, with 10-year carry forward of excess contributions
Michigan $10,000 above the line exclusion from income
 Mississippi $20,000 above the line exclusion from income
 Missouri $16,000 above the line exclusion from income
Montana $6,000 above the line exclusion from income
Nebraska $10,000 above the line exclusion from income
New Mexico Entire contribution amount
New York $10,000 above the line exclusion from income
North Dakota $10,000
Ohio $2,000 per beneficiary, per contributor or married couple, above the line exclusion from income, with unlimited carry forward of excess contributions
Oklahoma $20,000 per beneficiary, above the line exclusion from income, with five-year carry forward of excess contributions
Oregon $4,530 above the line exclusion from income, with four-year carry-forward of excess contributions
Pennsylvania $28,000 per beneficiary regardless of which state’s plan you enroll in
Rhode Island $1,000 above the line exclusion from income, with unlimited carry-forward of excess contributions
South Carolina Entire contribution amount, above the line exclusion from income
Utah 5% tax credit on contributions up to $3,800
Vermont 10% tax credit on up to $5,000 in contributions per beneficiary
Virginia $4,000 above the line exclusion from income, with unlimited carry forward of excess contributions
Washington, D.C. $8,000 above the line exclusion from income
 West Virginia Entire contribution amount up to extent of income, above the line exclusion from income, with five-year carry forward of excess contributions
Wisconsin $3,000 per dependent beneficiary, grandchild, or self

529 plan benefits deliver in a big way on taxes. But you may run into some trouble with the IRS if you use the money on nonqualified expenses. The IRS levies federal income tax and a 10% penalty on nonqulaified withdrawals. Some states may require you to pay back previously claimed tax deductions.

Reach out to a CPA or CFP to discuss tax implications of a nonqualified withdrawal. Your advisor should also recommend alternatives.

But as long as you use your savings on qualified expenses, you can enjoy all the 529 plan benefits including the following:

Most 529 Plans Carry Low Fees

Several 529 plan investment options charge only a total annual asset-based fee. But don’t worry. These aren’t charged out of pocket. Instead, they’re removed from your account based on the program management costs and fund-related expenses. Still, these fees usually dip very low to about 0.28% across plans.

529 Plans Are Easy to Manage

You don’t need to know anything about investing to manage a 529 plan. In fact, a lot of the work is done for you. Most plans offer hands-off investment options called age-based portfolios.

These automatically change their asset allocation, or the mix of bond and stock funds they invest in. As your child gets closer to college age, these portfolios aim to drive the bulk of your money toward less risky investments.

In addition, most plans allow you to make automatic contributions by linking your banking or savings account. Several plans don’t even require a minimum contribution. But you can open most accounts with as little as a $25 deposit.

529 Plans Can Fund More Than Just College

529 plan benefits

When most people think of college courses, they conjure up images of huge halls and kids scribbling notes. However, you can use your 529 plan money to study in a hands-on field at a technical school. Indeed, 529 plan benefits will cover your child’s education to become an auto mechanic.

529 plans fund qualified expenses at any school that participates in a financial aid program managed by the United States Department of Education. That umbrella covers four-year universities, community colleges, trade schools, technical schools and even culinary schools. Those who expect their children to broaden their horizons can even use the 529 plan money at certain foreign institutions.

Furthermore, the Tax Cuts and Jobs Act expanded 529 plan benefits. You can now use 529 plan money in part to fund private, public or religious K-12 schools. The law allows you to use up to $10,000 to pay tuition at such an institution per beneficiary, per year.

You Can Use 529 Plans With Scholarships

You don’t need to revoke your savings if your child gets a partial scholarship. Instead, you should use your 529 plan funds to reduce your college costs all the more. So feel free to search the top five places to find partial scholarships.

But in the event your child receives a full-ride scholarship, don’t feel as if you’re giving up all of your 529 plan benefits. You can still use the money to fund another family member’s education. Furthermore, the IRS allows you to make a penalty-free nonqualified withdrawal in the amount equal to the tax-free scholarship. However, you may still owe federal and state income tax on the withdrawal. Consult your financial advisor to discuss the tax implications of this move.

529 Plans Lightly Affect Financial Aid Eligibility

Your 529 plan assets affect your child’s financial aid eligibility to a small degree if you’re the custodial parent and account holder. In this case, the federal government counts only up to 5.64% of the account’s value into the student’s Expected Family Contribution (EFC). This formula determines a student’s federal financial aid eligibility.

But if the student serves as the account owner, the government factors a larger cut of up to 20% into the EFC.

If the account owner is someone else such as an uncle or a grandparent, the plan won’t count as an asset. However, withdrawals from the plan to cover the student’s education will count as the student’s untaxed income when he or she fills out future Free Application for Federal Student Aid (FAFSA) forms.

The federal government treats assets and income differently when calculating a student’s eligibility for financial aid.

But the general rule of thumb dictates a custodial parent should open the 529 plan account in order for a child to make the most out of potential financial aid packages.

529 Plans Permit Large Contribution Limits

Each state sets its own 529 plan contribution limit. These peaks typically range from about $200,000 to more than $500,000. If you’re worried about setting off a gift tax, 529 plans offer some wiggle room.

In fact, you can contribute up to $75,000 ($150,000 if married filing jointly) into a 529 plan at once. That amount climbs past the current $15,000 gift-tax exclusion. However, the IRS waives gift tax if you don’t make any more contributions for five years.

The IRS also permits you to contribute between $15,000 and $75,000 in a year. However, the government prorates these contributions through five years. So say you transfer $50,000 in one year. The IRS will treat it as $10,000 in contributions throughout five years. Thus, you can transfer up to $5,000 more each of those years while avoiding gift tax.

Overall, 529 plans offer several ways to give money to students while avoiding gift tax.

Anyone Can Open a 529 Plan

Anyone 18 or older with a valid Social Security or tax identification number can open a 529 plan. No rules restrict you to opening a 529 plan sponsored by your own state. You can shop around to see which plan offers the 529 plan benefits that appeal to you.

You can even open a 529 plan to fund your own education. Those expecting children can start saving right away by naming themselves as beneficiaries. Then, they can  designate their children as the beneficiaries after they’re born.

529 Plans Take Donations

529 plan benefits

Your friends and family can contribute toward your 529 plan. Some plans facilitate the process by providing you with a link you can email and share on social media to maximize your savings potential. Some states even allow others to make tax-deductible contributions into your 529 plan.

529 Plans Don’t Expire

Say your child decides not to go to school or takes some time off. Don’t fret. Your money stays in the plan. Your child can use it when he or she feels ready. You can also change beneficiaries to someone in the child’s immediate family without penalty. If you’re using a prepaid tuition plan, they typically have a 30-year limit.

How Do You Open a 529 Plan?

Now that you know all about the 529 plan benefits, you may be concerned about the process. Don’t worry. Most plans let you enroll online in as little as 15 minutes. Just make sure you have the following information about yourself and your beneficiary ready.

  • Social Security or tax identification numbers
  • Birthdates
  • Addresses

You should also have your bank account and routing numbers ready if you’re making an initial contribution electronically. But most plans accept checks as well. And remember, you’re not limited to investing in your own state’s 529 plan. No rules limit you to investing in just one plan either.

You can open a portfolio-based 529 plan account, while contributing toward a prepaid college tuition savings plan. So shop around. We’ve reviewed the 529 plan benefits, fees and other features of options across the country. A financial advisor can also help you create your own savings strategy utilizing one or more 529 plans based on your individual goals.

The Takeaway

529 plan benefits extend beyond tax breaks. You can open an account sponsored by any state regardless of residence. Any scholarship and financial aid money your child earns can combine with your 529 plan savings to cut down the cost of college even further.

In fact, you don’t even need to use your funds at a traditional college. Your child can use them at trade or technical school and more. And opening a 529 plan is as easy as a few mouse clicks.

Anyone thinking about ways to save for college should consider opening one.

Tips on Making the Most Out of a 529 Plan Benefits

  • 529 plans offer impressive tax benefits. But you can make the most out of these perks only when you use your funds on qualified education expenses. So make sure you know what they are.
  • 529 plan savings safely cover a bulk of college expenses you’re likely to encounter. But they can’t cover everything tax-free. So consider adding to your college savings arsenal. Look into Coverdell ESA, UGMA/UTMA accounts and more.
  • Encourage your child to take steps to get more financial aid.
  • Seek help from a financial advisor, who can tailor a unique savings strategy based on your individual goals. If you’re not sure where to find one, you can use our SmartAdvisor matching tool. It asks you a few simple questions to link you to different advisors that can meet your needs. From there, you can examine their credentials. You can also set up phone or in-person interviews to narrow down your options.

 

Photo credit: ©iStock.com/Steve Debenport, ©iStock.com/JohnnyGreig, ©iStock.com/ zimmytws

Javier Simon, CEPF® Javier Simon is a banking, investing and retirement expert for SmartAsset. The personal finance writer's work has been featured in Investopedia, PLANADVISER and iGrad. Javier is a member of the Society for Advancing Business Editing and Writing. He has a degree in journalism from SUNY Plattsburgh. Javier is passionate about helping others beyond their personal finances. He has volunteered and raised funds for charities including Fight Cancer Together, Children's Miracle Network Hospitals and the National Center for Missing and Exploited Children.
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