529 Plans
The school year is coming to a close across most of the country. With summer approaching and today being a special day (5/29), we wanted to remind you of a tax-advantaged tool that is available to almost anyone. If you’re family has any educational goals it is worth understanding the basics of 529 plans so that you or loved ones can be prepared for future education costs.
Education expenses like tuition and administrative fees have grown significantly over the last four and a half decades, especially when lined up against broader inflation numbers. Since 1980 the average college tuition and fees have grown by ~1,240% (~5.94% annualized inflation). If parents plan to assist with education expenses, it is prudent to save early and often and try to capture tax benefits where possible to cover the future expenses.
The History of 529 Plans
To help with increasing costs, 529 plans, also known as Qualified Tuition Programs, were born out of Section 529 of the Internal Revenue Code and quickly adopted by state and state agencies. Beginning in 1996, states began creating plans and by the end of 2000, 30 of them had developed and launched their own 529 plans. Today, each state (and the District of Columbia) has at least one plan for individuals and these plans continue to grow in popularity. As of July 2024, there are 16.8 million (up from 10.1 million in 2009) 529 savings accounts and total assets crossed over $500 billion (up from $133.4 billion in 2009).
Some states have two forms of Section 529 Plans – Prepaid Tuition Plans and Education Savings Plans.
Prepaid Tuition Plans allow for the purchase of units or credits at participating colleges and universities, which can help lock in tuition and fee rates. If the beneficiary attends a non-participating school the prepaid program may pay significantly less than the value that was accrued according to the cost of tuition at the participating schools. These plans are less popular given their rigidity.
Education Savings Plans tend to be more popular given their higher levels of flexibility. With these plans, investors open an investment account for a specific beneficiary to provide for future educational expenses. These accounts often include investment options such as mutual funds, target date or glide-path funds. The accounts are controlled by the investor who retains discretion to make distributions for the educational costs of the beneficiary.
Benefits of Section 529 Education Savings Plans
Some of the benefits of Education Savings Plans include:
Tax-free earnings growth and tax-free withdrawals on qualified higher education expenses. Qualified expenses include tuition, fees, books, room and board, and supplies that may be required for attendance.
The Tax Cuts and Jobs Act of 2017 allows 529 plans to pay for elementary and secondary school tuition - up to $10,000 per year.
The SECURE Act of 2019 allows for tax-free withdrawals from 529 plans to repay qualified student loans – up to $10,000 over a lifetime. No income deduction is provided on interest payments out of 529 plans.
The SECURE Act 2.0 allows for 529 plan funds to be moved directly to a Roth IRA. The lifetime limit is $35,000 per beneficiary amongst other rules and limitations.
Contributions from individuals to these plans can be made at any income level. This is a great way to get additional assets into tax-advantaged accounts beyond IRAs, qualified plans, etc.
Presently, investors are not limited to the number of beneficiaries for which they can set up individual accounts.
Individual investors can contribute $19,000 (in 2025) per year to any account. With “superfunding” investors can contribute 5x the annual gift exclusion (currently $95K) to a beneficiary in one year. Keep in mind this puts limitations on future contributions and/or gifts in the next four years.
Contributions are generally not considered part of the contributor’s estate.
The donor maintains flexibility to change the beneficiary of the account.
529 plans have the capacity to be pretty low maintenance since many include age-based portfolio allocations that become more conservative as the beneficiary gets closer to college age.
Many states do not require residency to use their plans.
When structured properly, a 529 plan may not reduce need-based financial aid opportunities through FAFSA.
Limitations of Section 529 Education Savings Plans
Although many benefits exist there are some limitations to Education Savings Plans as well:
10% penalty on earnings and earnings are included in gross income if not used for qualified education expenses.
There are maximum investment balance limits, which varies by plan.
Annual contributions above the gift tax exclusion (currently $19,000) do count against your lifetime estate and gift tax exemption, unless “superfunding.”
The account owner is limited to two investment changes per year (in most plans).
Funds must be used at a qualified educational institution. If studying overseas, the beneficiary needs to attend a Title IV college or university to qualify for tax-free distributions from the 529 plan. More than 400 foreign colleges are eligible for federal student aid.
Considerations Before Setting Up a 529
As you consider 529 plans, it's important to understand that not all are created equal. Some include higher minimum contributions when opening an account and fees can vary widely. In addition, investment options can differ along with the underlying fees of the investments. And although residency is typically not required to participate, there may be benefits (e.g. no state income tax on withdrawals and state income tax deductions on contributions) to utilizing a plan within the state you call home.
A Tool for More Than Just Current Parents!
It is also important to keep in mind that 529 plans are relevant tools to more individuals than just parents. You do not need to have a child to begin considering these as a part of your financial picture as you can give to nieces, nephews or any other beneficiary.
For the generations that may be concerned about potential estate taxes (e.g. grandparents or great-grandparents) and want to move assets outside their estate, 529 plans can be a great option. Or perhaps you are an aunt or uncle that would prefer not to purchase another stuffed animal as a birthday gift, but would rather put that money towards future education costs (or maybe you do both!). And for couples without kids (but want to have kids or adopt), you can open a plan under your own name (change the beneficiary later) and begin saving towards your future child’s education today. The flexibility of 529 plans makes them relevant to more than just current parents which makes the benefits more accessible to a broader range of savers.
If you need assistance thinking through how a 529 plan might fit in your financial picture, please feel free to reach out. We would be happy to discuss!
Research:
Intro: School year ending. https://www.visualcapitalist.com/rising-cost-of-college-in-u-s/
https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html
https://www.sofi.com/learn/content/percentage-of-parents-paying-for-college/
