What is a 529 Plan?
The 529 college savings plan is an investment instrument that provides the account holder tax benefits when utilized to pay a chosen beneficiary, which is your children, for a qualified tuition programs or education expense. In the beginning, it was confined to the expense of post-secondary education, extended in 2017 and in 2019 to cover K-12 education.
Back in 1986, when the Michigan Education Trust (MET) developed a prepayment tuition plan, the education saving plan was first created. Section 529 (also known later as 529 plans) established the tax-free status for eligible tuition programs, introduced to the internal revenue code over a decade later. More than 100 different 529 plans with various college savings requirements are available today.
Savings plans are tax-deferred, and withdrawals are tax-free when used for qualifying expenditure on education. Prepaid tuition plans enable the account owner to pay tuition in advance at selected institutions and colleges, thus setting the cost at current rates.
In general, there are three types of 529 plans: savings plans, prepaid plans, and ABLE plans. So now, let’s move on to each of these types of 529 plans.
One of the most common types of 529 plans is the savings plan. The savings plans function similarly to common retirement plans such as 401k or IRAs (Traditional IRA & Roth IRA) through investments in mutual funds or similar assets. In addition, the savings plan provides you with many choices of investments to select from.
Since the money will be invested in mutual funds or assets, it can go up and down following the market’s activity. On the other hand, the money you invest will follow the market’s movements, meaning that the amount of your money can increase or decrease as well.
The 529’s savings plan is available through direct investment or a financial advisor like Cameron James. Opening a 529’s savings plan account through a direct investment will require you to learn more about your options to choose which investment is suitable for you. Suitable means that the investment is adjusted with your financial situation, risk profile, and future planning.
The prepaid plan is the second-common 529 type of plan that is available for you. In prepaid plans, you can pay all or part of the fees of public university education in the state in advance. They can also be changed to private and non-state schools for usage. Prepaid plans are divided into two types: contract and unit plans.
This attractive plan enables families to afford future tuition charges at a supposedly reduced cost as today. However, the prepaid plan itself has become an unusual commodity. While 22 states offered them, by 2020, this figure had fallen to only nine.
The prepaid plan works by pooling investors cash to earn sufficient funds that exceed the rising education costs. Essentially, in return for the locked-in tuition rate, you lend your money to the 529 state plan, in monthly payments or with a lump sum.
Another type of 529 plan is the ABLE plan. ABLE (Achieving a Better Life Experience) is designed specifically for Americans with disabilities. Those with disabilities can save up to $15,000 yearly inside a tax-deferred account.
The funds from the ABLE account are eligible to be used for paying qualifying disabilities expenses for the designated beneficiaries. When used to pay for qualifying disabilities expenses, the withdrawal is tax-free.
The fund in the savings plan or prepaid plans is allowed to be rolled over to the ABLE plan of the designated beneficiary. However, keep in mind that the maximum rollover amount is limited. Therefore, the ABLE plan is suitable for people with disabilities to maintain their independence, health, quality of life, and education.
What are the Tax Benefits of a 529 Plan?
Essentially, 529 plans are known for their tax benefits offered. The contributions made into your 529 plan account are growing tax-free, which means you can invest your money without having to worry about the tax. Obviously, of course, as you use the fund to pay for education purposes.
As of January 2018, you may withdraw your tax-free contributions up to $10,000 annually per beneficiary. This money is eligible for the purpose of education expenses for private, public, or religious elementary and secondary schools. In addition, in 2019, apprenticeships programs and student loans were added as qualified educational expenses.
Furthermore, many states offer state income tax deductions or credit for 529 plans. Your 529 plan tax deduction will depend on where you live and the amount of contribution you have made to a 529 plan in the tax year.
How to Open a 529 Account?
There are two ways you can open a 529 account. You can open it directly through your state’s plan, or you can open an account using an independent financial advisor.
If you choose to open a 529 plan by yourself, you have to investigate the plan’s benefits and downsides that may come up when you’re starting your contributions. All in all, you have to manage and oversee your own 529 account, which means you are the only person who will be responsible for anything happening with your 529 plan in the future.
The alternative and safer choice is, opening your account through an independent financial advisor like Cameron James. With the help of an independent financial advisor, you will have a few advantages. First, you may select from several 529 plans available in the state. However, if you choose a plan from a state outside of your plan, you may give up some of your state’s tax deductions.
Second, with the help of an expert, you will be able to plan for all your financial education goals effectively. The plan will be adjusted for your objectives and financial situation, which means that you’ll have a more realistic and achievable plan in place.
Now how much should I contribute to a 529 plan?
The contribution allowances vary across the states. If you’d like to understand the minimum amount of your monthly contribution, you should check with your 529 state’s plan administrator. There you can find the monthly minimum and maximum amount of contribution, plan types and fees, plan manager, investment manager, and the tax benefits that you can earn.
Subsequently, you can leave all of those decisions to Cameron James; our independent financial advisors will be happy to help you to choose the best 529 plan for your educational savings for your child.
Most of the 529 plans offer you but are not obliged to set up automatic contributions through direct deposits arranged using your bank account. Instead, the 529 plans will require you to pay minimum initial contributions as low as $25 to open your 529 accounts. After paying the initial contributions, you will then be able to freely contribute to your account whenever and in any amount you desire.
Will It Affect Existing Financial Aid with a 529 Plan?
We received a lot of similar questions from our clients. Families are often concerned about having 529 accounts while receiving financial aid.
Will it reduce the amount? If yes, which one will be reduced? How much will it be?
The answer to this question relies upon two questions: who is the owner of the account and when the withdrawal occurs. In most cases, your 529 will not reduce the money in your financial aid and vice versa. In fact, it will even assist you in increasing the amount of your educational funding.
However, the value of a 529 account is considered the parents’ asset by the FAFSA (Free Application for Federal Student Aid). Therefore, roughly the first $10,000 will be treated as the FAFSA Asset Protection Allowance. The financial aid calculator determines that at most, 5.6% of the investments will be used for education, even though your family would likely use 100% for education expenses. This is a good thing, as it means only 5.6% you won’t be eligible to receive financial aid for.
For example, if you have a 529 account worth $50,000, the FAFSA will presume a total of $2,820 will be considered college cost, which means that you won’t receive $2,820 in financial aid.
It can be complicated and stressful to save and pay for schools, but it doesn’t have to be! You have many great options. So make the most of it. Consulting with an independent financial adviser and a customer care department of your 529 plan before making any decisions is always a smart idea.
How Can I Make 529 Withdrawals?
Withdrawals can be made annually by sending a withdrawal request to your 529 account administrator online via email or by phone call. In addition, you may withdraw your 529 tax-free savings for the payment of registration and participation at selected in-state or out-of-state, public and private colleges, universities, and other eligible post-secondary academic institutions.
A 529 plan qualified expenses include up to $10,000 per annum of K-12 education costs. You may withdraw any amount you wish, but the tax-free part will only be for the 529 plan qualified expenses. If you’re using the money for other purposes, you will be subject to income tax and an extra 10% penalty.
It is important to carefully calculate the right amount of money to withdraw to cover all of your expenses. Another point, it is good to withdraw your 529 funds at the same time you pay the educational expenses. For instance, do not include last year’s or next year’s education expenses in this year’s 529 withdrawals. Keep this year’s 529 withdrawals only for this year’s education expenses.
Once everything is completed and set up, you can start to submit a withdrawal request through email or phone call. Typically, the withdrawal request will require you to fill in these credentials:
- 529 account number
- Name, SSN (Social Security Number), TIN (Taxpayer Identification Number)
- Beneficiary’s name & SSN (Social Security Number)
- Phone number
- Identification number
What If I Don’t Withdraw My 529 Plan Contributions?
When it comes to leftovers in your 529 accounts, there are some actions that you can choose to do with your funds:
- Use the money to pay for student loans
- Withdraw the funds subject to income tax and an extra 10% penalty
- Maintain the funds in your 529 for later educational expenses
- Change the recipient to a qualified family member that will use the money later
- Save money for your future generation (grandchild)
529 Savings Plan or Coverdells?
Another alternative of US education savings is Coverdell. Similar to 529 plans, Coverdell is also a savings account that you can use to grow your savings tax-free for educational expenses purposes. You can choose to save your money to a 529 or Coverdell account. You can click here to discover our detailed guide about Coverdell.
However, before deciding which plan is right for you, it is better to understand them first. What they offer, benefits and downsides, and other things you have to consider. 529 plans and Coverdells have their own benefits and disadvantages where you can learn more about below.
|Plan eligibility||No restrictions||Beneficiaries must be under 30 except for people with disabilities.|
|Income limit||No income limit||
|Investment control||Yes, with limited choice of investments.||Yes, a wide range of choices of investments.|
|Minimum contribution||$15,000 annually||$2,000 annually|
|Tax benefits||Yes, both on contributions and distributions.||Yes, both on contributions and distributions.|
|Account opening choice||
|Change of beneficiary||Yes||Yes|
Which Type of 529 Plan is for Me?
529 plans are available in many states in the US. As a parent, perhaps it’s an overwhelming thing to choose from so many 529 plans. You have to compare each benefit and disadvantages, the fees and taxes involved, the minimum and maximum contributions, how to make the withdrawals and when is the best time to do it, and what to do when there are funds left on your 529 plan account.
You have to consider all of these things carefully before you decide which state’s 529 plan is best for you. Moreover, you also have to think about your financial condition and your family’s future planning to get a suitable 529 plan adjusted to your situation. Finally, if you’d like to try it yourself, you can follow these steps to pick the best plan for you.
Compare and Research Available 529 Plans
The first thing you need to do is research all 529 plans in the US available for you. You can start by listing all of them and considering these criteria in your research:
- Offered savings options
- All costs and taxes involved
- Your 529 manager
- Investment return
- Benefits for the states’ resident
- Performance rating
- Overall rankings
If you choose to buy directly, it may give you lower costs since you are not required to pay for any commissions. However, you have to bear all the risks that may come up along the road.
Let Cameron James Help Choose Your 529 Plan
A safer way to choose the right plan for you is by getting advice from an independent financial advisor. Not only will you get the best 529 plan suited to your financial situation and future planning, but your 529 accounts will also be taken good care of, in the good hands of the well-regarded financial advisors in the industry, Cameron James.