Tax-deferral can have a dramatic effect on the growth of an investment. With a state-sponsored 529 College Savings Plan your contributions can grow tax-deferred (some states allow contributions to be partially or completely deductible) and distributed income tax-free as long as distributions are used for qualified education expenses such as tuition, fees, room and board at higher education institutions.
Start planning for your child’s future today with our 529 college savings plan calculator.
There is no limit on contributions but some states tend to limit contributions once the plan assets have reached a defined maximum (typically $230,000 – $500,000). Under a special election, you may make contributions of up to $75,000 per beneficiary in a single year without triggering a federal gift tax by accelerating five years’ worth of contributions (gifts) as of 2021. Married couples may contribute $150,000 per beneficiary in a single year.*
Assets are professionally managed by fund managers selected by the state. Participants can choose from two to almost 30 mutual fund-type investments. Control of the account remains with the contributor regardless of the age of the beneficiary.
* A $75,000 gift is viewed as an accelerated gift over five years. Any other gifts to the same beneficiary by the contributor within five years may result in a federal gift-tax liability. If the contributor dies within the five-year period, a prorated portion of the contribution may be included in his or her taxable estate for federal estate tax purposes.
What Can You Pay for With the 529 College Savings Plan?
When you have a 529 college savings plan, you can withdraw funds for several educational institutions, including:
- K-12
- Trade school
- College
- Graduate school
The approved uses of these funds vary. If you use them toward your child’s K-12 education at a private school, for instance, you can only withdraw $10,000 per year for tuition expenses — you can’t use them to cover uniforms, transportation or other costs related to their education. In comparison, part- and full-time students at trade schools, graduates schools, and accredited colleges can use their 529 funds on several items, including:
- Tuition
- Books
- Room and board
- School supplies
- Special needs equipment
However, like K-12 students, you cannot use the 529 college savings plan to cover the cost of traveling to your campus or paying off student loans.
What Investment Choices Come With a 529 College Savings Plan?
In most instances, when you open a 529 college savings plan, you’ll do so with a mutual fund, which a financial company manages. By investing in a mutual fund, you let an experienced professional manage your funds according to the portfolio type, which may be conservative, growth or balanced. If you’re starting the fund after welcoming your child, for instance, you may opt for a portfolio with growth objectives because you have several years before your child enters college.
Upon opening your account, you’ll choose between two options:
- Age-Based: A choice that many parents make is for an age-based approach to stock. The advantage of this option is that it adapts automatically to your child’s age. As they get closer to 18, the portfolio becomes conservative. It starts, however, as an aggressive, growth-orientated portfolio.
- Static: For maximum control of your 529 college savings plan, you can opt for a static approach to stock. This option does not respond to your child’s age. It continues as a growth, conservative or balanced fund until you decide otherwise.
If you’d prefer not to open a college savings investment plan, you could opt for a prepaid tuition one, which locks in today’s prices for tuition. These plans are less popular, as prepaid tuition plans tend to provide funds for only public colleges and universities in the state. Plus, they only cover tuition, which leaves you with the cost of books, room and board and any other expenses.
What Fees and Federal Policies Affect 529 College Savings Plans?
There are numerous benefits of 529 savings plans, but they do come with some fees you should be aware of beforehand, including:
- Advisor
- Management
- Maintenance
- Investment
In some states, tax deductions are available for 529 college savings plans, which could offset the above charges.
A few policies govern your 529 plan, too. The first is that only one person can claim ownership of a 529 — you can’t share it with your partner, for instance — and you can name only one beneficiary to that plan. If you have multiple children, you and your partner can own several separate accounts and name a child to each, but their total annual withdrawals cannot exceed the designated limit. While ownership is singular, numerous people can contribute to a 529 plan.
Keep in mind that if your charitable giving throughout your lifetime goes over $5.6 million, you will need to pay gift taxes on any contributions you make to a 529 college savings plan, too.