What Is 529 College Savings Plan? Does It Really Work?

A 529 plan is one of the tax-advantaged college savings plans that is designed to help pay for education.

Originally it was limited to post-secondary education costs, but it was later expanded to cover K-12 education in 2017 and apprenticeship programs by 2109.

Post the Setting Every Community Up for Retirement Enhancement Act of 2019 [SECURE Act] and SECURE 2.0 of 2022; you can now use a 529 to pay off student loans or to fund a Roth IRA.

The 529 plan is divided into two major types, namely –

• Education Savings Plan
• Prepaid Tuition Plans

Education Savings Plan grows tax-deferred, and the withdrawals are tax-free if they are put to use for qualified education expenses.

The Prepaid Tuition Plan allows the owner to pay current tuition rates for attendance at designated colleges or universities in the future.

This means you can most likely lock in a lower price for college attendance.

Five hundred twenty-nine plans are also known as Qualified Tuition Programs or Section 529 plans.

Key Takeaways  

• Five hundred twenty-nine plans are one of the college savings plan accounts that are used to pay education expenses starting from kindergarten all throughout graduate school.

• A 529 plan is divided into two types: prepaid tuition plans and educational savings plans.

• 529 plans are sponsored and operated by the 20 states and the District of Columbia. The fees and rules for the 529 plan differ from state to state.

• 529 can either be purchased directly from the state or through a financial advisor or broker.

• From 1st January 2024, up to $35,000 of the leftover funds in a 529 account may be rolled over into a Roth IRA account, given the fund is at least fifteen years old.

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Roots Of 529 Plans  

529 plans may derive their name from Section 529 from the federal tax code; however, the 50 states, along with the District of Columbia, implement the plans.

Although anyone can necessarily open a 529 account, it is more common for parents or grandparents to open a 529 account where the child or the grandchild is the account’s beneficiary.

In selective status, individuals that fund the account may be subjected to a state tax deduction for their benefactions.

The funds in the 529 plan grow on a tax-suspended basis till the time it is withdrawn.

The best part about the 529 plan is that the funds are not subjected to any state or federal taxes as long as they are put to use for educational expenses as established by the IRS.

Additionally, selective states may offer tax reductions on contributions.

For K-12 students, tax-less deductions are limited to $10,000 a year.

However, tax benefits may vary depending on the state. So it is necessary to check for the details of any 529 plan to understand what special tax benefits you may or may not be qualified for.

Types Of 529 Plans   

There are two major types of college savings plans that are included under the 259 plans.

Let us see what these plans are and how beneficial they are for college goers.

Education Savings Plans  

They are the more common types of 529 college savings plans. The account holder donates funds to the plan. That fund is then invested in a pre-set selection of investment alternatives.

The account holders are free to invest where they want to invest, mostly in mutual funds. The investments’ performance will determine the account value’s growth over time.

Many 529 college savings plans offer “target date funds,” which help in adjusting the assets as the years pass by, becoming more and more conservative as the beneficiary grows closer to college age.

Funds from the 529 college savings plans can be withdrawn for both educational and K-12 qualified expenses. The said qualified expenses may include fees, tuition, room and board, and other related costs.

The SECURE Act of 2019 expanded tax-less 529 plan withdrawals to comprise register apprenticeship program costs and up to $10,000 for debt payment of student loans for both account beneficiaries and siblings.

Prepaid Tuition Plans  

These plans are limited to selective states and a few higher education institutes.

However, the specifics may vary, but the base principle remains the same. They allow you to save in tuition fees now rates for a beneficiary that might not be attending college anytime soon.

A prepaid plan, however, is not applicable to K-12 education.

As with 529 college savings plans, the value of a prepaid tuition plan also grows over time.

Consequent withdrawals from the account, which are used to pay for tuition, are not subject to taxes. The prepaid tuition plan does not cover room and board, unlike the savings plan.

A prepaid tuition plan may put restrictions on which colleges they are used for. However, the funds in the savings plan can be used for almost any eligible college or institution.

Additionally, the funds in a prepaid tuition plan do not get a guarantee by the federal government and may not be pledged by selective states.

Therefore, make sure you understand all the aspects of a prepaid tuition plan.

Advantages Of 529 College Savings Plans  

Here are some of the advantages of 529 college savings plans:

• They have a high contribution limit.

• They have a flexible plan location.

• They are easy to open and maintain.

• Tax suspended growth.

• The withdrawals are tax-less.

• Contributions are tax-deductible.

Disadvantages Of 529 College Savings Plans  

529 plans have a few drawbacks too. They are mainly:

• There are limits to investment options.

• The fee levels are different in each state.

• Fees may vary; restrictions imposed on changing plans.

• Restrictions imposed on switching investments.

• Mandatory use for educational purposes.

• Restrictions may apply depending on the state.

529 Plans Rules For Transfer  

529 college savings plans have special rules that the federal tax code [Section 529] governs.

The owner may be able to transfer the funds to another 529 plan only once each year unless there is a change of beneficiary. You do not have to change the plan in order to change beneficiaries.

However, you may be able to transfer the plan to anyone in the family who identifies as:

• Daughter, son, foster child, stepchild, or the descendant of them.
• Sister, brother, stepsister, or stepbrother.
• Mother or father or their ancestors.
• Stepmother or stepfather.
• Daughter or son of a sister or brother.
• Sister or brother of mother or father.
• In-laws
• The spouses of the individuals listed above.
• A first cousin.

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The Bottom Line  

Building 529 college savings plans gives you a tax-beneficial way to save for expenses for education starting from kindergarten to graduate school, which also includes apprenticeship programs. Multiple options to use your 529 plan provide great flexibility and the possibility for tax-free growth for future scholars.

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