529s
4 Things You May Not Know About 529 Plans
As college prices and the burden of student loans continue to rise, so does the need to be diligent about education planning. There are many ways to lower the costs of college, including community college, work-study programs, grants, scholarships, and more. However, as parents (and grandparents), starting a 529 savings plan is one of the most beneficial ways to help ease the burden in funding your child’s education.
529 savings plans are tax-advantaged investment vehicles that can be used penalty- and tax-free for qualified education expenses. You can contribute up to $18,000 annually (as of 2024) of after-tax dollars without affecting your lifetime gift tax limit. For married couples, this limit goes up to $36,000. Those contributions grow tax-deferred and can be withdrawn tax-free for college tuition, room, board, supplies, and more.
While many parents know that the 529 plan is a great savings vehicle, not many understand some of the nuances to help them optimize the account to the fullest extent. Here are four things you may not know about 529 plans, but probably should:
1. You don’t have to use the funds for college.
529s have been broadened overtime to include a number of qualified education expenses beyond college funding. Perhaps the largest opportunity is the ability to use 529 funds for qualified apprenticeships and trade schools. This allows students to pursue lucrative careers that don’t require a degree - like an air traffic controller, real estate agent, or electrician - and still receive the same financial support. You can also withdraw up to $10,000 for qualified student loan repayments, including an additional $10,000 for student loans from the beneficiary’s siblings. Lastly, you don’t even have to wait until your child is in college to withdraw funds from the account. You can use 529s tax-free for many K-12 private tuition expenses, up to $10,000 annually.
2. If your child doesn’t need the money, you don’t lose it.
Many parents worry about overfunding their child’s 529 plan. While the cost of college is substantial, many students end up receiving large amounts of scholarships, grants, or simply don’t go to college. While overfunding may lower the tax benefits of 529s, you do not simply lose the money that you have contributed. Perhaps the simplest way to make the most of the overfunded account is to change the beneficiary of the 529 to a new member of the family. This includes keeping the account for a future grandchild. You can also roll over amounts tax-free from one plan to another every 12 months without needing to change beneficiaries.
If your child receives a scholarship, you can use funds for other education expenses such as room, board and supplies, or you can save it for potential graduate school funding. You may also be able to withdraw up to the amount of their tax-free scholarship penalty-free. You will need to pay taxes on the investment gains, but your initial contributions will all be tax-free.
If there are still funds remaining, your child can rollover distributions annually into their Roth IRA. The rollover will count toward the annual contribution limits for Roth IRAs ($7,000 for 2024), and they cannot rollover beyond this amount annually. However, it could still be a great way for them to get a head start on their retirement planning!
Lastly, in a worst-case scenario, you can always remove the funds from the 529 account with the 10% penalty and income taxes on the earnings of your account for non-qualified expenses. Since your initial contributions were taxed federally, you will not be “double-taxed” on that amount. However, if you received a state tax deduction, you may need to pay state taxes back on the contributions.
3. You can forward-fund your plan.
If this is the first year you opened the 529 account for the beneficiary, you can actually contribute five year’s worth of funding all in the first year without affecting your lifetime gift tax. Instead of $18,000, you can contribute up to $90,000 all at once. The catch is you won’t be able to contribute any additional dollars for the next 5 years. So why does forward-funding matter? If you have the funds to contribute, this gives you five extra years of compounding growth! If your account made an 8% rate of return, forward-funding would result in an additional $18,193 of growth at the end of the five years compared to contributing annually.
4. The earlier you start, the better the plan is!
It’s important to start saving early. Since 529 contributions are not tax-deducted (with the exception of some state plans), the 529 plan does not have a strong benefit in the short-term. The true benefit of these plans is the tax-deferred growth and the tax-free withdrawals over a long period of time. Need another reason to start early? Many plans also give matching contributions if the beneficiary is below a certain age. We never want you to fund your child’s education at the expense of your own financial security. However, small amounts of just $100 per month while they are young can go a long way.
How Do I Choose a 529 Plan?
Every state has their own 529 plans. When comparing plans, you may come across two types of 529 plans. We have focused on 529 savings plans, where you save and invest for future education expenses. These are the most common and the most flexible options! There are also 529 prepaid plans where you can buy “credits” for college semesters and lock in current prices for future tuition. These plans may only apply to in-state schools, are often restricted to in-state residents only, and are only available in eight states. For those reasons, the majority of 529 plan owners choose a 529 savings plan instead.
If your state of residence has a plan that allows for a state income tax deduction or a contribution match, this is likely a great place to start! However, you will also want to factor in investment options and fees to your decision. If your state does not have any benefits and does not have the investment options or fees that you are looking for, you can compare all 529 plans and look for which allow out-of-state residents. There are many great plans out there, and many are extremely similar. It is less about finding the “perfect” plan, and instead about finding one that is a great fit for you.
529 Considerations for Foreigners Living In the US
The good news is that 529s in any state are available to non-US citizens as long as you have a Social Security number. Additionally, 529s allow students to study at many international schools (called “eligible foreign institutions”) and still qualify for tax-free withdrawals. Your child could opt to go to school in the US, in your home country, or elsewhere with no effect on the US tax treatment! However, there are foreign tax considerations that add a layer of complexity to your college planning.
Unfortunately, there are no tax treaties with the US that recognize the tax-deferred status of 529 accounts. This means that, depending on your country, your gains and distributions may be taxed in your home country, even if they are not taxed in the US. Because beneficiaries are often not the owners of the account though, you may be able to change the account ownership to a trusted, US-based family member. It is also worth noting that local college savings plans like an ISA (United Kingdom) or RESP (Canada) are not recognized in the US and will not be treated favorably either.
It is always worth talking to a financial advisor to better understand the international treatment of your college savings plans, and to find the most optimized path for you and your family. The typical path of a 529 or other tax-advantaged plan may or may not be the right fit for you. If it turns out it is not the option for you, there are still many strategies for college planning that may be a better fit.
The Bottom Line
Education is an incredible tool, but planning for it can feel overwhelming. For many families, supporting their kids through college is one of the largest expenses they will ever plan for. The great news is that there are many government support systems put in place to help you. 529 savings plans are among the most flexible and optimized options. If you need help choosing a 529 plan, you want help optimizing it, or you want to know what other savings vehicles are out there, reach out for a chat. We’d be happy to help build a plan that will create peace of mind for you and your family.