The Nitty Gritties of the 529 Savings Plan

As the leaves are changing colors and summer turns to fall; it’s a great time to get serious about education funding. One of the most popular college funding accounts is the 529 Savings Plan, and we’re running out of time to get one up and running this year so let’s get down to the details…

In contrast to prepaid tuition, a 529 savings plan, referred to as a 529, allows you to open an account specifically for education. You have the ability to invest your money inside of the plan, typically in mutual funds. Similar to an employer-sponsored retirement plan, you’ll have a list of investment options to choose from. You can’t invest in whatever you want, but the plans typically provide a variety of options to provide adequate diversification. Most plans have age-based portfolios, which invest the child’s funds based on an age range. For a younger child, the portfolio is invested more aggressively and becomes more conservative as the child ages and is closer to making withdrawals from the account. Similar to other investment accounts you may have, you can choose how and when you would like to contribute. The return on your investment in a 529 savings plan is not guaranteed and will fluctuate with the market so research your options to determine your appropriate asset allocation.

Pros of 529s

Tax advantages: 529 savings plans allow you contribute after-tax money and that money will grow tax-deferred. All earnings are tax-free as long as you use the money for qualified education expenses during the distribution phase. Qualified expenses are laid out in each plan’s prospectus, and they typically include tuition, fees, computer technology, and room and board.

State Tax Deductions: 34 states including the District of Columbia offer state tax breaks or incentives on your tax return for contributions made to the plan, usually in the form of a deduction or credit. The deduction applies to the tax year in which the contribution was made so you only have until December 31st to receive the deduction this year.

Gifting advantages: Gifting into these programs has also become popular in recent years. A single filer can gift up to $75,000 into a 529 plan per beneficiary in one year without having to pay the gift tax. The gift is treated as if it was given over a five year period.

Cons of 529s

Lack of control: With a 529 savings plan you will have limits on what you can and can’t do with the account. First and foremost, the intention of these plans is to make it easier for families to save for college, so these accounts don’t work well when utilized for other priorities. You’re also limited to the investment options provided by the plan so you won’t have the freedom to invest however you want.

Penalties: If you spend the money for purposes other than qualified education expenses, you must pay taxes on your earnings and an additional 10% federal tax.

Beneficiary restrictions: 529 plans allow you to transfer the account tax-free to another beneficiary as long as that beneficiary is a family member or yourself. So if you choose your child as a beneficiary and then need to change it, you won’t be able to choose anyone as the beneficiary, but you will have the flexibility to share it with siblings. Typically, 529 plans allow you to change the beneficiary once per year if needed.

Traditionally these accounts were for college and other post-secondary training. As of 2018, the qualified education expenses now include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

Wondering whether a 529 will fit into your financial plan? CLICK HERE to see if Merino Wealth can help!

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