A Brief History
With growing concern over the ever-increasing cost of higher education and the feeling that the Federal government's answer to the education IRA was not going to be enough. Some states started offering incentives for families to save for college. Although 529 plans have been around in some form or another since the late '80s. There was still concern that the earnings from a state-sponsored educational account might not be federally tax-free. That was until 2001 when the Economic Growth and Tax Relief Reconciliation Act completely exempted earnings of a 529 plan from federal taxation. Currently, all 50 states now sponsor a 529 plan with some even offering state tax exemptions.
How it works
529 plans are state-sponsored and many of the options such as maximum contributions, the type of plan (savings or prepaid tuition), state taxation, and the investments inside, can differ greatly from state to state. For this blog, I will stick to the general rules and provide a link below so you can find the information on your specific state. Anyone can open a 529 account for a beneficiary. There are no annual contribution limits, but they do have a maximum contribution limit ranging from $235,000 to $500,00 depending on the state. Contributions grow tax deferred and if used for "qualified educational expenses" come out tax-free. In 2017, 529 plans were amended to allow $10,000 per year to be used for grades k-12 including both public and private schools. There are two types of 529 plans the savings plan and the prepaid tuition plan
Savings plan
The savings plan works much like a ROTH. You put in money on after-tax bases, the investments grow tax deferred and if used for "qualified educational expenses' come out tax-free.
Pre-Paid Tuition Plan
Prepaid Tuition plans, though less common, allows for the contributor to pay for future college costs at today's rates. They usually come in the form of purchasing units or credits or a certain number of years of tuition. Prepaid tuition plans are designed to apply to the state that is sponsoring it, so there could be limitations if the student wants to go to a different university. Also they generally only cover tuition, leaving out things like books, room and board, and equipment.
The Funding
529 Plans can be funded by anyone, making them an ideal spot for cash gifts. Although there are no annual funding limits on 529 plans. They are subject to federal gift tax rules. Meaning if you contribute more to the gift tax exclusion, currently $16,000 for 2022, you will be subject to the gift tax.
The Investments
As stated earlier the investments inside a 529 plan differ greatly from state to state. They usually have 3 options, age-based portfolios, Risk Adjusted portfolios, or static portfolios.
1. Age-based Portfolio
Age-based portfolios will adjust the risk level in the underlying investments as the beneficiary get older. Starting with a more aggressive approach and getting more conservative as the beneficiary gets close to college age.
2. Risk Adjusted Portfolios
Risk-adjusted portfolios are composed of a combination of stocks, bonds, or mutual funds, put together to achieve either a conservative, growth or aggressive growth allocation model. The type of model you select will remain that way until you change it.
3. Static Portfolio
A static portfolio is a portfolio that you choose from a list of available investments. It can be just one investment or split up into many to create your portfolio.
Just A Few More Things
Unlike the Coverdell ESA, there are no age limits on 529 plans. A person can be both the account owner and the beneficiary. If the funds are not used for "qualified educational expenses" then a 10% penalty on the earnings will apply to the withdrawal. If the beneficiary decides to not go to school then the money can be rolled over to another "eligible" family member. Which can include immediate family and extended family. If the beneficiary ends up getting a scholarship you can withdraw the amount of the scholarship without the 10% penalty.
Is it Right for Me?
A 529 plan is a great way to save for the high cost of secondary education. Now being available, at least in part, for grades K-12 along with their high contribution limits. They have the potential to cover a wide variety of your education funding needs. Visit this website www.collegesavings.org to learn more about your state's 529 plans options
Thanks
Tom