What are 529 plans?

529 plans provide significant benefits to beneficiaries and account owners, and are sponsored by educational institutions, states, and state agencies. Surely you are wondering what are 529 plans? We will explain it to you right away.

What are 529 plans?

529 plans are college savings plans that offer tax benefits and financial aid. However, they can be used to save and invest for K-12 tuition as well, not just to cover college costs.

There are two types of 529 plans: college savings plans and prepaid tuition plans. Almost every state has at least one 529 plan. There is also a 529 plan operated by a group of private colleges and universities.

Keep reading: How much money can I withdraw from a savings account in the United States?

We already know what 529 plans are, but what about their history?

The first of these plans was a prepaid tuition established by the Michigan Education Trust (MET) in 1986.

529 plans are named after Section 529 of the Internal Revenue Code (IRC), which was added in 1996 for the purpose of granting tax-free status for “qualified tuition programs.” Earnings from these plans accumulate on a tax-deferred basis and distributions are not taxed by the federal government when used for qualified higher education expenses.

The definition of qualified higher education expenses has been expanded several times, in 2015 to include computers, in 2017 to include up to $10,000 annually in K-12 tuition, and in 2019 to include student loan payments and apprenticeship costs.

What are 529 plans?

Can I use a 529 plan for any college?

The reality is that you can invest in a 529 plan from almost any state, not just your state. With these plans you can pay for college costs at any qualified university in the country.

In most cases, your choice of college is not affected by the state that sponsored your college savings plan.. You can be a California resident, invest in a Vermont plan, and send your student to college in North Carolina.

This plan can be used at more than 6,000 US colleges and universities and more than 400 foreign colleges and universities.

What states offer 529 plans?

Almost all states have at least one 529 plan available. It is up to each region to decide if they will offer any plan (possibly more than one) and what it will look like. Therefore, the terms and conditions may differ from state to state. You should investigate the features and benefits of your plan before investing, know the options offered by each state and compare them to choose the one that best suits your needs.

Fiscal benefits

As long as the plan meets a few basic requirements, federal tax law provides special tax benefits, as an average of 5 years of gift tax and qualified tax-free distributions.

Some states also offer state tax incentives to investors. These include tax deductions and tax credits for contributions to the state’s 529 plan. You should inform yourself about the tax management of your state.

Types of 529 Plans

529 plans are often classified as prepaid tuition plans or college savings plans.

College Savings Plans

These work much like a Roth 401(k) or yet Roth IRA, investing your after-tax contributions in mutual funds or similar investments. The College Savings Plan offers several investment options to choose from. The account will go up or down in value based on the performance of the investment options.

Prepaid Tuition Plans

They allow you to pay in advance all or part of the costs of your public college education in the state. They can also be converted for use at private and out-of-state universities. The Private College 529 Plan is a separate prepaid plan sponsored by more than 250 institutions.

Educational institutions may offer a prepaid tuition plan but not a college savings plan.

Keep reading How to withdraw money from the 401K?

What can a 529 plan be used for?

A 529 plan is an investment account that offers tax-free earnings growth and tax-free withdrawals, as long as the funds are used to pay for qualified education expenses. For colleges, universities, and other post-secondary educational institutions, this includes tuition, fees, books, supplies, equipment, computers, and sometimes room and board.

The IRS also allows tax-free withdrawals of up to $10,000 per year, per beneficiary to pay tuition expenses at private, public and religious K-12 schools.

Tax-free distributions can be used to pay off federal and private student loans.

What is not covered by the 529 plan?

The funds in a 529 plan are yours, and you can always withdraw them for any purpose. However, the earnings portion of a nonqualified distribution will be subject to ordinary income taxes and a 10% penalty, although there are exceptions.

At the university or post-secondary level, a general rule is that the expenses required for enrollment in an eligible institution are covered. However, there are some expenses that you might consider necessary but are not considered qualified by the IRS.

For example, a student’s medical insurance and transportation expenses are not qualified expenses, unless the college charges them as part of a comprehensive tuition fee or the fee is identified as a “required enrollment or attendance” fee at the college.

Are contributions to the 529 plan tax deductible?

As in the case of the Roth IRA, contributions to a 529 plan are post-tax and are not deductible for federal taxes. However, more than 30 states and the District of Columbia offer state income tax deductions or tax credits for contributions you make to the plan, although you may be required to invest in your home state plan to claim the benefit .

Remember that the funds grow free of federal taxes and will not be taxed when the money is withdrawn for qualified education expenses.

What are the qualified education expenses for a 529 plan?

Qualified expenses include tuition and fees, books and supplies, room and board (for students enrolled at least half time), computers and related equipment, Internet access, and special needs equipment for students attending an eligible college, university, or other post-secondary educational institution. Transportation expenses and medical insurance are not considered qualified expenses.

The Tax Cuts and Jobs Act of 2017 also allows for tax-free distributions of up to $10,000 per year, per recipient, to pay for K-12 tuition at private, public, and religious schools.

The SECURE Act of 2019 allows for tax-free student loan repayment distributions of up to $10,000 per borrower (lifetime limit) to the beneficiary and their siblings.

The earnings portion of a nonqualified withdrawal may be subject to federal and state income tax, as well as a 10 percent tax penalty. Since your contributions are made with after-tax money, they will never be taxed or penalized.

Can I use a 529 plan to pay rent?

Yes, room and board are considered a qualified expense if the student is enrolled at least half time, which most colleges and universities consider to be at least six credit hours per quarter.

For on-campus residents, qualified room and board expenses cannot exceed the amount charged by the university for room and board. For students living off campus, qualified room and board expenses are limited to the “cost of attendance” figures provided by the university. Contact the financial aid office for more information.

How do I use my 529 plan?

Once you’re ready to start taking withdrawals from a 529 plan, most plans allow you to make payments directly to the account holder, beneficiary, or university. Some plans may allow you to make a payment directly from your 529 account to another third party, such as the landlord. Remember that you will need to check with your own plan to learn more about how to take distributions.

Depending on your circumstances, you may need to report plan contributions or withdrawals on your annual tax returns.

What if my child doesn’t use the 529 plan?

The future is always uncertain, and some parents worry about losing the money they saved in a 529 plan if their child doesn’t go to college or receive a scholarship. Generally, you’ll have to pay income tax and a penalty on the earnings portion of a nonqualified withdrawal, but there are some exceptions. The penalty does not apply if:

  • The recipient receives a tax-free scholarship
  • Recipient attends a United States Military Academy
  • The beneficiary dies or becomes disabled

However, your earnings will be subject to federal, and sometimes state, income tax.

Keep reading: What is a SIMPLE IRA?

What happens to unused money in a 529 plan?

If you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:

  • Change the beneficiary to another eligible family member.
  • Keep the funds in the account in case the beneficiary wants to attend graduate school later.
  • Make yourself a beneficiary and study for a career.
  • Transfer the funds to a 529 ABLE account, a savings account specifically for people with disabilities.
  • Beginning January 1, 2018, parents also have the option to take up to $10,000 in tax-free withdrawals for K-12 tuition.
  • Starting January 1, 2019, qualified distributions from a 529 plan can repay up to $10,000 in student loans per borrower, for both the beneficiary and their siblings.

Remember: you can always withdraw the money left over from your plan. However, the earnings portion of a nonqualified withdrawal will be subject to taxes and a penalty, unless you qualify for one of the exceptions listed above. If you are considering a non-qualified distribution, check carefully the rules and conditions under which you can do this.

What happens if I can’t pay the monthly payments?

Most plans have minimum initial contribution requirements (sometimes as low as $25) but after that, it’s up to you. While some families prefer to set up automated monthly deposits because they want to “set it and forget it,” others choose to make contributions around birthdays, holidays, or other occasions. With a 529 college savings plan, you can contribute what you want, when you want.

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