For many parents, the opportunity to pay for their children’s education means setting them up for success later in life. Among the myriad of savings options available, 529 savings plans offer a wide range of benefits that provide flexible ways for families to save. Ryan Mefford, a Financial Advisor at First Mid Wealth Management, explains how 529 plans work and why contributing to these plans can benefit both students and their families.
What is a 529 plan and who is it for?
A 529 College Savings Plan is a state-sponsored investment plan that enables you to save money for a beneficiary and pay for education expenses. You can withdraw funds tax-free to cover nearly any type of college expense. 529 plans may offer additional state or federal tax benefits.
How does a 529 plan benefit parents and children?
- 529 plans offer unsurpassed income tax breaks. Although contributions are not deductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college. As of January 1, 2018, tax-free withdrawals may also include up to $10,000 in tuition expenses for private, public, and religious elementary and secondary schools (per year, per beneficiary). In 2019, student loan payments and costs of apprenticeship programs were added as qualified education expenses. Other savings vehicles — such as mutual funds — will surrender a portion of their earnings to annual income taxes and get hit with a capital gains tax at withdrawal. This has been a huge incentive for Americans to save for college. The tax treatment was made permanent with the Pension Protection Act of 2006.
- Your own state may also offer tax breaks. In addition to federal tax savings, more than 30 states offer a full or partial tax deduction or credit for 529 plan contributions. You can generally claim state tax benefits each year you contribute to your 529 plan, so it’s a smart idea to continue making contributions until you’ve paid your last tuition bill. Research all your options — if your state doesn’t offer benefits for residents, you can choose any other state’s plan.
- You’ll benefit from high contribution limits. 529 plans have high aggregate limits and no annual contribution limits, unlike other types of savings plans. Depending on the state you live in, the maximum aggregate limit or lifetime contribution limit can range between $235,000-$550,000. These high contribution limits help you maximize the tax benefits associated with 529 plans.
- You can use 529 plan contributions to reduce your taxable estate. There are generous limits for 529 plan contributions to be seen as gifts for tax purposes. In 2022, deposits to a 529 plan up to $16,000 per individual per year ($32,000 for married couples filing jointly) will qualify for the annual gift tax exclusion. Those looking to reduce estate taxes can elect to treat a 529 plan contribution of between $16,000-$80,000 as if it were made over a five-calendar-year period to qualify for the annual gift tax exclusion**. This type of accelerated gifting will reduce your personal taxable estate and is unique to 529 plans.
- You stay in control of your account. With few exceptions, the named beneficiary has no legal rights to the funds in a 529 account, so you can assure the money will be used for its intended purpose. This differs from custodial accounts under UGMA/UTMA where the child takes control of the assets once they reach legal age. A 529 account owner can withdraw funds at any time for any reason — but keep in mind the earnings portion of non-qualified withdrawals will incur income tax and an additional 10% penalty tax.
- These plans are low maintenance. A 529 plan is a hands-off way to save for education. To enroll, visit our Best 529 Plans page and select the plan that seems best for you or contact your financial advisor. Most plans allow you to “set it and forget it” with automatic investments that link to your bank account or payroll deduction plans. The ongoing investment management of the account is handled by an outside investment company hired as the program manager or by the state treasurer’s office.
- You’ll enjoy simplified tax reporting. Contributions to a 529 plan do not have to be reported on your federal tax return. You won’t receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals.
- 529 plans are highly flexible. You can change your 529 plan investment options twice per calendar year and you can roll over your funds into another 529 plan once in a 12-month period. Tip: There is no federal limit on the frequency of these changes if you replace the account beneficiary with another qualifying family member at the same time.
- Everyone is eligible to take advantage of a 529 plan. Unlike Roth IRAs and Coverdell Education Savings Accounts, 529 plans have no income limits, age limits, or annual contribution limits.
What types of educational institutions are eligible?
Any postsecondary educational institution that meets accreditation criteria and is eligible to participate in Federal Student Aid programs is generally eligible. This includes institutions nationwide (not just in Illinois) such as: public and private colleges and universities; vocational, trade, technical, and professional institutions; and even some foreign schools.
What tax benefits are available with a 529 Plan?
In some states, contributions to any state’s 529 plan are eligible for a state income tax advantage. Out-of-state investors are not required to choose their home state plan to get the benefit but can select any state’s 529 plan.
Illinois taxpayers can deduct up to $10,000 in contributions from their taxable income each year ($20,000 if married filing jointly). Missouri taxpayers can deduct up to $8,000 in contributions from their taxable income each year ($16,000 if married filing jointly).
Investors should first consider whether their or their beneficiary’s home state offers any benefits such as scholarship funds, financial aid, and protection from creditors that are only available for investments in such state’s qualified tuition program. Investors should also consult their tax advisor, attorney, or other advisor regarding their specific legal, investment, or tax situation.
How much can you invest in a 529 Plan?
A minimum contribution is not required, nor do you have to contribute to your account every year. The program has no minimum initial or subsequent required contributions to an account. The aggregate maximum account balance limit for accounts for a beneficiary in the program and in other Illinois Section 529 Programs is $500,000, while the maximum investment amount allowed in Missouri is $550,000. Accounts that have reached the maximum account balance may continue to accrue earnings, but additional contributions will not be accepted.
How often should you contribute to a 529 Plan?
You may contribute to a 529 plan at any time throughout the year and you do not have to stop making contributions once the beneficiary reaches a certain age. However, some families may want to complete their annual contributions by a specific date to maximize state income tax benefits and the annual gift tax exclusion.
Can a 529 Plan set up in one state be used to attend college in another?
You can use a 529 plan from any state to pay for an eligible college in any other state. You might, however, wish to direct new contributions to the new state’s 529 plan to take advantage of the state income tax breaks on contributions to the state’s 529 plan. State income tax breaks are generally limited to the 529 plan for the state of residence, although seven states provide their state income tax breaks for contributions to any state’s plan.
Why should investors open a 529 Plan with First Mid Bank & Trust?
With more than 100 prepaid tuition and 529 college savings plans in existence, you can easily get confused in finding a plan on your own. Often, confusion leads to inaction, and you may simply never get around to taking that first step and opening a 529 account.
Let a First Mid financial advisor help you navigate through the account opening process to eliminate any confusion or inaction.
Article Sources:
Saving for College: https://www.savingforcollege.com
Bright Directions: https://brightdirections.com/tax-benefits/
Missouri’s 529 Education Plan: https://www.missourimost.org/home/529-features/tax-advantages.html
Links are being provided for information purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members.
Some investment products and services are not deposits, obligations or guaranteed by the bank; not insured by the FDIC or any other governmental agency, and may be subject to investment risk including potential principal loss.
Securities are offered through Raymond James Financial Services, Inc. member FINRA / SIPC, an independent broker/dealer, and are not insured by FDIC or any other bank insurance or government agency, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risks including the possible loss of principal. Raymond James Privacy Notice.
Raymond James financial advisors may only conduct business with residents of the states and/or jurisdictions for which they are properly registered. Therefore, a response to a request for information may be delayed. Please note that not all of the investments and services mentioned are available in every state. Investors outside of the United States are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this site. Contact your local Raymond James office for information and availability.
First Mid Bank & Trust and First Mid Wealth Management are not registered broker/dealers and are independent of Raymond James Financial Services. Investment advisory services offered through Raymond James Financial Services Advisors, Inc.
Check the background of this firm on FINRA’s BrokerCheck.
Rules and laws governing 529 plans are varied and subject to change. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
**Tax laws and provisions may change at any time. Death of the contributor prior to the end of the five-year period may results in a portion of the contribution to be included in the contributor’s estate. Please consult a qualified tax professional to discuss tax matters.
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
