Guide to 529 Plans

529 plans are tax advantaged plans used to fund education. They get their name from Section 529 of the Internal Revenue Code. Typically, parents or grandparents establish them for the benefit of a child, also known as a beneficiary. In this article, we will go over how 529 plans work.

Types of 529 Plans

There are two types of 529 plans, education savings plans and prepaid tuition plans. First, are education savings plans. There is the more common type of 529 plan. With this type of plan an account holder can contribute money to the plan. They can invest these funds in a preset selection of investment options. How these investments perform will determine the account growth over time. Second, are prepaid tuition plans. These plans allow you to lock in tuition at current rates for students that will not be attending college for several years. This plan may limit which colleges it can be used at and does not cover room and board.

Tax Advantages

Withdrawals from 529 plans that are for qualifying education expenses are tax free. Qualifying expenses include the following:

• College, graduate, and vocational school tuition and fees
• K-12 tuition and fees
• Books and school supplies
• Student loan payments
• Room and board
• Computers, internet, and software used for schoolwork
• Special needs and accessibility equipment for students

If withdrawals are made for other purposes, they are subject to taxes as well as an additional 10% penalty.

Gift Tax Implications

In 2024 you can give up to $18,000 to an individual without it counting against your lifetime exemption. This exemption, in 2024, is $13.62 million for an individual or $27.22 million for a couple. However, with a 529 plan you can contribute up to five years’ worth of gift tax in a lump sum without it triggering gift tax consequences. This would mean a $90,000 contribution. It is important to note that you cannot make additional contributions for the next 5 years or it will count against your lifetime exemption.

Benefits and Drawbacks

As with any investment vehicle, there are both benefits and drawbacks to 529 plans. Some of the benefits include the fact that these accounts have a high contribution limit. 529 plans are easy to open and operate. Also, they provide tax-deferred growth and tax-free withdrawals. They can also provide tax deductible contributions.

Some of the drawbacks include the fact that they have very limited investment options. Additionally, there can be restrictions on switching investments. The funds in these accounts are restricted and can only be used for education.

529 Plan Verses Brokerage Account

Some may wonder whether or not a brokerage account can accomplish the same things as a 529 plan. But there are large differences between both. First, is the purpose of the funds. With 529 plans the funds are set aside specifically for educational expenses whereas brokerage account funds are for general purposes with no tax benefits. Second, are the investment options. 529 plans have limited investment options which usually include mutual funds or EFTs. On the other hand, brokerage accounts allow you to invest in options, stocks, bonds, mutual funds, and EFTs. Third, 529 plans offer tax deferred growth and tax-exempt withdrawals. Brokerage account’s gains and dividends are taxable in the current period.

Utilizing 529 Plans

529 plans can help fund education for the children that you love. Meet with your advisor to help you get one set up.

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