Many families want to help their children or grandchildren attend a prestigious private school or university. If you are well off, a 529 plan may be your best bet due to its substantial tax savings.

Definition of a 529 Plan.

Individuals and families can benefit from the tax advantages of a 529 plan by setting aside money now for higher education costs down the road. This type of plan is regulated by Internal Revenue Code Section 529, hence the plan’s name.

Similar to a Roth 401(k) or IRA, but with the added benefit of using the funds tax-free for college costs rather than retirement.

The Function of a 529 Plan

There is no limit to the number of 529 plans an individual can establish, and the beneficiary can be anyone (a kid, grandchild, friend, or even yourself).

Grandparents can either start their own 529 plan or contribute to one the child’s parents have already started.

After-tax contributions to a 529 plan earn tax-free interest and payouts after retirement.

Often referred to by its technical name, “qualified tuition plans,” these programs are backed by legitimate state governments, state agencies, or accredited educational institutions. Visit the College Savings Plan Network to search for and evaluate different options.

Let’s take a look at the benefits of 529 plans.

There is a lot of wiggle room in how tuition is defined.

A 529 plan’s benefits extend far beyond funding higher education. A yearly maximum of $10,000 is available for use toward any level of education, domestic or international, from kindergarten through graduate school. This includes two-year associate degree programs, trade schools, and vocational institutions. If you already have student loans, you can use the $10,000 to pay them off.

In addition, Section 529 money can be spent on almost any college-related expense, including courses, supplies, and living expenses.

The estimated room and board fee can cover living expenses for nine months out of the year.

The 529 plan cannot be used to pay for university-provided health insurance for students.

You Can Change Who Gets The Money

A 529 plan beneficiary can be anyone the account holder chooses. If the original beneficiary doesn’t spend the money, the account holder can re-designate another family member as the recipient without paying additional taxes or penalties.

A word of caution, though: you can only sometimes make modifications. Some plans only allow one beneficiary change every year, while others require a certain event to occur.

A 529 plan can help you save money on taxes.

The tax benefits of a 529 plan are significant. As long as the funds are used for eligible tuition and related expenditures, the investment growth inside the plan is tax-free. Investing in a way that avoids taxes can lead to substantial savings over time.

Contributions to a 529 plan are eligible for additional tax benefits in several jurisdictions. State income tax exemptions and credits are two examples of these advantages, which can lower a person’s taxable income.

Additionally, the Benefits of an Estate Plan

A 529 plan allows your contributions and earnings to grow free of the estate tax. You are still the sole administrator of the account.

You Will Not Lose Access to Your Money

The money in a 529 plan remains in the account until the recipient is at least 18 years old. This regulation safeguards that the money is spent as planned.

The Choice Is Now Yours if School Budgets Are Not Necessary

If your 529 plan has been open for at least 15 years, you can transfer up to $35k to a Roth IRA starting in 2024.

Challenges Posed by 529 Plans

529 plans are more useful for the wealthy.

According to data from the Brookings Institution, the benefits of 529 plans are limited for all but the wealthiest households.

Possible Repercussions on Scholarships and Grants:

Financial aid may be affected by a 529 plan, but this is a highly nuanced topic.

The 529 account owner is the primary factor in determining whether or not the beneficiary’s financial aid would be affected. Some things to keep in mind are:

• Whether the 529 is in the name of a parent or a student, the first $10,000 is not considered to determine federal student aid eligibility.
• Only 5.64 percent of parental assets are considered for those who have saved more than the allowance, whereas 20 percent of student assets are considered.
• When calculating “base-year income” to determine eligibility for financial aid, distributions from accounts owned by parents or students are excluded.
• The value of a grandparent’s or other relative’s assets will not be considered for determining financial aid eligibility. However, on the FAFSA, money taken from a grandparent’s account is considered the student’s income. For example, if a grandmother pays $5,000 of a student’s expenses, it could cut the student’s financial aid eligibility by $2,000.

NOTES: The FAFSA considers income from the past two years, so a grandparent should hold off on funding the junior and senior years of college until after the student has applied for and been awarded federal financial aid.

The streamlined FAFSA will less affect financial aid eligibility for the school year 2023–24 if a grandparent owns a 529 plan.

It’s better to save for your retirement FIRST than your kid’s college.

Contributing to the development of future generations is rewarding. Seeing your grandchildren succeed in their endeavors, such as going to college is rewarding.

Rapid City, South Dakota-based certified financial planner Sarah Swantner says, “We find that a lot of parents and grandparents feel some sort of emotional obligation to pay for college, and they’ll do that at the expense of their retirement.”

Spending heavily on kids’ or grandkids’ schooling can derail retirement savings and add stress to the lives of retirees.

“They could be doing more harm than good,” says certified financial adviser Debbra Dillon of Eagle, Idaho’s Dillon Financial Planning. “If they don’t have millions saved up to support retirement and college, they’re going to put their kids in the position of having to take care of them [financially],” the author says.

Rarely Used

The funds in a 529 plan can be transferred to a retirement account, but its primary purpose is to pay for college.

The money could be liable to taxes and penalties if utilized for non-allowable purposes.

Fees incurred by a 529 plan’s administration, management, and other sources can reduce the result. The costs of various plans should be weighed carefully before selection.

Additional Information on 529 Plans

Limits to How Much You Can Put In

With a 529 plan, your contributions are unlimited. However, for federal tax purposes, donations to these accounts are treated as gifts, and any amounts contributed in 2023 that exceed the annual gift tax exclusion ($17,000) will reduce the lifetime estate and gift tax exemption available to you.

In 2023, a married couple can donate twice as much—$34,000—because two people will contribute.

A single, large payment is another possibility. If no further donations are made to the same recipient in the next 5 years, you can contribute $85,000 all at once (the equivalent of $17,000 per year over 5 years).

The total amount that can be contributed to a 529 plan in a given state is similarly capped. Certain restrictions apply to the combined contributions that can be made on behalf of each beneficiary. These caps are between $235,000 and $550,000. (The cap is based on the total cost of a costly undergraduate and graduate education program, which includes tuition, fees, books, and living expenses.)

Typically, several investing options will be available.

In most 529 plans, you can invest in a wide variety of mutual funds and age-based portfolios. Each investor has their own risk tolerance and time horizon, therefore their portfolio should reflect that.

However, compared to other investment vehicles, your 529 plan will likely have fewer investment possibilities.

College expenses can be set in stone with a 529 plan.

You can use 529 funds to prepay tuition if the beneficiary attends a public school in your state (or a private school that is part of a consortium). Lock in today’s tuition rates by paying in advance. As tuition rises each year, you are still out of pocket.

Possible Gains from Consulting a Financial Advisor to Weigh Your Options

Due to their complexity, you can talk to a financial planner or tax expert about these accounts.

Is it Reasonable to Consider a 529 Plan?

So, first things first. Consider how a 529 plan can alter your long-term savings, investments, and retirement prospects. If you need more money to cover college expenses, use the NewRetirement Retirement Planner to find out.

The calculator can also simulate the financial benefits of a Section 529 plan. Contributions can be created and modeled, along with the tax consequences.