Why 529 plans can help prepare for the near and distant future

The cost of education continues to climb to the point where many parents and students simply acknowledge they will need to take out significant loans in pursuit of a diploma or degree. By planning early, parents and grandparents can help eliminate, or significantly decrease, the need to be saddled with debt before they even get started.

A 529 plan is a tax-advantaged savings plan designed to help pay for education. Originally limited to post-secondary education costs, it was expanded to cover K-12 education expenses in 2018 and apprenticeship programs in 2019. The two major types of 529 plans are savings plans and prepaid tuition plans – also referred to as qualified tuition programs and Section 529 plans.

Savings plans

Savings plans are the most common type of 529 plan. The account holder contributes money to the plan that is usually invested in mutual funds. Many of these mutual funds offer target-date funds.  This allows the 529 plan account holder to decide how aggressive or conservative they want their investments to be as they near the time to withdraw funds for the beneficiary.

While there is no guarantee that the amount of money in a 529 savings plan will cover all the school expenses, you can work with a financial planner to help account for inflation and future prices of tuition and school-related expenses.

Prepaid tuition plans

Prepaid tuition plans allow the account owner to pay in advance for tuition at designated colleges and universities while locking in the cost at today’s rates. These plans are very rare and are becoming more so. There are a limited number of states that have this program and most are moving away from this and towards the savings account plan.

How 529 plans work

529 plans are tax-advantaged accounts that can be used to cover educational expenses from kindergarten through graduate school. The qualified expenses are tuition, fees, books, room and board, supplies, equipment, and meals.

Anyone may open a 529 account, as they are typically established by parents or grandparents on behalf of a child or grandchild, who is the account’s beneficiary.  The beneficiary of the account does not have to be a family member and can be transferred if circumstances warrant.

529 plans are administered by each state and differ among them all.  These plans are transferable between states. For example, if you have a 529 plan in Georgia, you can use the money to pay for school in another state.

There are no limits on how much you can contribute to a 529 account each year, but many states put a cap on how much you can contribute in total. These limits typically range from $235,000 to $525,000 or more.

What are the tax benefits?

The money in the 529 account grows on a tax-deferred basis until it is withdrawn. If the money is used for qualified educational expenses, those withdrawals are not subject to state nor federal taxes. In the case of K-12 students, tax-free withdrawals are limited to $10,000 per year.

The money contributed to a 529 plan is not tax deductible for federal income tax purposes, but most states provide a state tax deduction or credit for contributions to these plans.

What if funds are left over?

What happens if you have money left over in a 529 plan?  Perhaps because the beneficiary earned significant scholarships or decided not to go to college after all.  You could change the beneficiary on the account to another relative, or you could keep the current beneficiary in case they change their mind about college or later go to graduate school. If neither of these options is viable, you could cash in the account and pay the taxes plus a 10% penalty.

Planning for the near and distant future is important to protect your bottom line and minimize your tax liability, but also to set up your family in the best financial position possible.

Your tax manager here at Antares Group is ready to guide you if you would like more information on setting up a 529 plan.

Krystle Keys, CPA, is a Manager with our Business & Tax Advisory Group. She can be reached at kkeys@antarescpas.com.