Savings with 529 Plan for your child’s future education: Are 529 plans worth it ? 529 plan is one of the best ways to save for education expenses, it is a tax-advantaged savings plan that allows you to save for qualified education expenses.
In this post, we will discuss the technical details of 529 plans. It further includes details for Vanguard 529 plan and other state-sponsored plans, their investment options, fees, tax benefits and more.
529 Plan Overview
A 529 plan is a tax advantaged savings plan designed to help families save for future qualified education expenses, including tuition, fees, books, and room and board. The plan is named after Section 529 of the Internal Revenue Code, which created this type of investment vehicle.
Who is a beneficiary in 529 Plan ?
A beneficiary refers to the prospective student for whom the account is established. This could be a child, grandchild, friend, or even yourself.
Two main types of 529 plans:
Both are tax-advantaged investment vehicles designed to encourage saving for future college costs, but they differ in terms of their investment options and how they can be used.
- College savings plans: College savings plans are the most common type of 529 plan. A 529 college savings plan can be used at a wide variety of post-secondary educational institutions. This include Colleges and universities, community college, international universities, etc. as long as they are eligible. You can use the money in the account to pay for qualified education expenses, such as tuition, fees, room, books, and supplies.
- Prepaid tuition plans: Allows you to lock in current tuition rates by prepaying for future college expenses at eligible educational institutions. These plans are typically offered by state governments and allow you to purchase credits or units that can be used to pay for future tuition and fees at eligible colleges and universities. These plans may also cover room and board, but typically only at in-state schools. Example: Florida Prepaid College Plan, Texas Tuition Promise Fund.
- Anyone who is a U.S. citizen or a resident alien can open a 529 plan, regardless of income.
- There are no age restrictions on the beneficiary.
- The beneficiary of a 529 plan can be changed to another family member at any time, and funds can be used at most accredited colleges and universities in the United States and many abroad.
529 Plan Penalties and Restrictions:
Fees for 529 Plan:
529 plans generally have low fees compared to other types of investment accounts and it may differ from one plan to other.
Tax Benefits of 529 Plan:
- Contributions to a 529 plan are made with after-tax dollars, but earnings grow tax-free, and withdrawals for qualified education expenses are also tax-free.
- In addition to federal tax benefits, many states also offer tax benefits for residents who invest in their state-sponsored plan. These benefits may include tax deductions or credits for contributions to the plan, or tax-free withdrawals for qualified education expenses.
Following States Offer Tax Deductions:
|District of Columbia||Georgia||Idaho||Illinois||Indiana|
|Nebraska||New Jersey||New Mexico||New York||North Dakota|
|South Carolina||Utah||Vermont||Virginia||West Virginia|
It’s important to note that the rules and limits for these deductions vary by state, so it’s important to check with your state’s 529 plan program for specific details.
Following States Do Not Offer Any Tax Deductions:
|Kentucky||Maine||Nevada||New Hampshire||North Carolina|
However, residents of these states can still invest in any state’s 529 plan and enjoy the federal tax benefits of these plans, such as tax-free growth and withdrawals for qualified education expenses.
Comparison of Popular State Sponsored 529 Plans:
|Plan Name||Annual Maintenance Fee||Underlying Fund Expenses|
|Vanguard 529 Plan||0.14% (waived for balances over $50,000)||0.10% – 0.35%|
|New York 529 Plan (NYSAVES)||0.16%||0.15% – 0.63%|
|Utah Educational Savings Plan||0.14%||0.08% – 0.37%|
|Ohio College Advantage 529 Plan||0.25%||0.19% – 0.69%|
Vanguard 529 Plan:
The Vanguard 529 plan is a state-sponsored plan available to residents of all states with a variety of investment options, including age-based, static, and individual funds. It offers low fees, with an annual maintenance fee of 0.14% and underlying fund expenses ranging from 0.10% to 0.35%, depending on the investment option selected. The plan automatically adjusts the investment mix as the beneficiary gets closer to college age.
NYSAVES 529 Plan:
The New York 529 plan (NYSAVES) is a state-sponsored plan available to residents of any state. It offers a variety of investment options, including age-based options, static options, and individual funds. The plan has low fees, with an annual maintenance fee of 0.16%, which is waived for balances over $25,000. Underlying fund expenses range from 0.06% to 0.50%, depending on the investment option selected. Additionally, New York residents may be eligible for state tax deductions on contributions to the plan.
529 Plan Investment Options:
Money deposited in 529 Plan can be invested using following options.
- Age-based Portfolios: Are a popular option for many investors, as they automatically adjust the investment mix based on the age of the beneficiary. The portfolio starts out more aggressive when the beneficiary is younger, gradually becoming more conservative as the beneficiary approaches college age.
- Static Investment: This include a mix of stock, bond, and money market funds, as well as other investments like index funds, exchange-traded funds (ETFs), and target-date funds. Account owners can choose from a range of risk levels, from conservative to aggressive, depending on their risk tolerance and investment objectives. Keep in mind that the static option requires account owners to manually reevaluate and adjust their investment strategy as needed.
- Individual Funds: Allow you to select specific mutual funds to invest in. This option gives you more control over your investment mix but also requires more research and decision-making on your part.
How to Choose the Right 529 Plan
To select the best 529 plan for your needs, consider the following factors:
- State Tax Benefits: If your state offers tax benefits for 529 plan contributions, it may be advantageous to choose an in-state plan.
- Investment Options: Review the plan’s investment options and choose one that aligns with your risk tolerance and investment preferences.
- Fees: Compare plan fees, including management fees and any account maintenance fees.
- Plan Performance: Evaluate the historical performance of the plan’s investment options, keeping in mind that past performance is not indicative of future results.
Sample Investment Growth in a 529 Plan :
- Starting balance: $0
- Monthly contribution: $1,000
- Investment period: 13 years (from when the child is 5 years old until 18 years old)
- Estimated rate of return: 6% per year
- Fees: 0.25% program management fee and 0.50% investment fee
- Total contributions over 13 years: $156,000 ($1,000/month x 12 months/year x 13 years)
- Estimated ending balance: $282,721.84 (annual rate of return of 6%)
- Total fees over 13 years: $7,125.92 ($2,444.12 program management fee + $4,681.80 investment fee)
- Net investment returns: $275,595.92 ($282,721.84 – $7,125.92)
In conclusion, a 529 savings plan offers a powerful way to invest in the future of a loved one’s education. By leveraging the tax advantages and flexibility of these plans, you can help make the dream of higher education a reality.
As you embark on this educational journey, keep in mind that the key to maximizing the benefits of a 529 plan lies in understanding its features, investment options, and strategies. Be sure to explore static and age-based investment options, and don’t forget to consult with a financial advisor if needed.
For more information, download our comprehensive guide on 529 savings plans, which delves into details such as contribution limits, qualified expenses, and more.
Frequently Asked Questions (FAQs)
What happens if you don’t use 529 money?
If you don’t use the money in a 529 plan for qualified education expenses, the earnings portion of non-qualified withdrawals will be subject to income tax and a 10% penalty. However, you can avoid these consequences by changing the beneficiary to another eligible family member, transferring the funds to an ABLE account, or using the funds for qualified apprenticeship programs or student loan repayments (subject to limits).
What are 2 main benefits of 529 plans?
The two main benefits of 529 plans are tax advantages and flexibility. Earnings in a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free. Additionally, 529 plans offer flexibility by allowing you to change beneficiaries and choose from a variety of investment options.
What happens to 529 if the child doesn’t go to college?
If the child doesn’t go to college, you can change the beneficiary to another eligible family member even the grandchild, or transfer the funds to an ABLE account for a disabled family member, or use the funds for qualified apprenticeship programs or student loan repayments. Alternatively, you can make a non-qualified withdrawal, which will be subject to income tax and a 10% penalty on the earnings portion.
What is the 529 loophole?
The term “529 loophole” generally refers to strategies that maximize the tax benefits of 529 plans. One such strategy is “superfunding,” where you contribute up to five years’ worth of the annual gift tax exclusion ($75,000 per contributor as of 2021) in a single year. This allows the money to grow tax-free and can provide significant savings on gift and estate taxes.
Can a parent take money out of a 529?
Yes, a parent can take money out of a 529 plan. However, if the withdrawal is not used for qualified education expenses, the earnings portion will be subject to income tax and a 10% penalty.
Should I open a 529 for each child?
Opening a separate 529 plan for each child allows you to tailor the investments and risk level to each child’s age and future education needs. However, you can also open a single 529 plan and change the beneficiary as needed.
How long does money need to be in a 529 before withdrawal?
There is no specific holding period for 529 plan contributions. However, it’s advisable to keep the money in the plan long enough for it to grow and provide tax-free earnings.
Can you roll 529 into a Roth IRA?
Yes, starting in 2024, you can withdraw funds from a 529 plan and roll them into a Roth IRA, thanks to a new law. It’s essential to follow specific rules: The Roth IRA must be established for the beneficiary of the 529 plan (the student), not the account owner (usually a parent). This change allows for greater flexibility in using 529 plan funds for future financial needs.
Does 529 count as income?
Withdrawals from a 529 plan for qualified education expenses do not count as income for the beneficiary. However, non-qualified withdrawals will be subject to income tax on the earnings portion.
Is a 529 plan worth it ?
A 529 plan can be beneficial for a any timeframe, as it offers tax-free growth and withdrawals for qualified expenses. We have entire post going into detail to know if 529 plan worth it compared to other savings options.
How much is $100 per month in a 529 worth after 18 years?
The future value of $100 per month in a 529 plan depends on the investment return and the number of years the contributions are made. For example, if you contribute $100 per month for 18 years and assume an average annual return of 6%, the total amount in the 529 plan would be approximately $41,000. This amount includes both your contributions and the earnings generated from the investments. Keep in mind that actual investment returns may vary, and past performance does not guarantee future results.
Finally, don’t forget to share your own experiences and advice on 529 savings plans in the comments section below.