Are you looking for a smart way to save for education expenses? We recommend a 529 plan as a great way to start saving.
Whether you’re a parent, grandparent, or even an aunt or uncle, understanding the benefits of a 529 plan can help you make a wise financial decision for your loved one’s future. So, let’s dive in and discover how you can use it to pave the way to a brighter future.
What is a 529 Plan?
Before we delve into the benefits, let’s start with the basics. A 529 plan is an education savings plan designed to encourage families to save for future qualified higher education expenses. It is named after Section 529 of the Internal Revenue Code, which governs these plans. Depending on the type of 529 you choose, funds can be used for tuition, fees, books, supplies, and even certain room and board expenses at eligible educational institutions.
The Types of 529 Plans
There are two types of 529s: savings plans and prepaid plans. The right one for you depends on what you want the funds to cover.
Similar to 401K plans, this option lets you fund the account and the money is invested in a variety of different stocks, bonds, mutual funds, and/or money market funds.
All 50 states offer this 529 plan and they are often more flexible because you can use the money for most qualified college expenses including:
- Toom and board
With this option, you prepay for semesters of college tuition at the current rates. This locks in the price so you don’t have to worry about increasing tuition prices.
However, these 529s are more restrictive and only lock in tuition prices at certain participating schools. If your child attends a nonparticipating school, you will be able to transfer the value, but there is no guarantee that it will be enough to cover the full tuition.
Also, some of these plans only cover tuition and no other expenses such as room and board, or textbooks.
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Benefits of a 529 Plan
Federal & State Tax Advantages
One of the significant benefits of a 529 is its tax advantages.
Contributions made to a 529 plan grow tax-deferred, meaning you won’t pay taxes on the earnings as long as the funds are used for qualified educational expenses.
Additionally, some states offer tax deductions or credits for contributions made to a 529 plan, reducing your overall tax burden.
Many states sponsor their own plans, which offer additional benefits and special incentives, including:
- Matching grants
- Scholarship opportunities
- Lower fees
Check out SavingforCollege.com to learn more, including how to set up a 529 in your state and your state’s unique advantages to boost your savings potential.
High Contribution Limits
Total maximum contribution limits are typically quite high, allowing you to save more over time. While each state has it’s own limit, the typical range is $235,000 to $400,000.
These generous limits ensure that you can adequately prepare for the risking cost of education.
No Income or Age Restrictions
Unlike some other education savings options, 529 plans do not impose income limits or restrictions on who can contribute. Their inclusive nature makes them accessible to families across various income levels, allowing more individuals to take advantage of the benefits they offer.
The named beneficiary (your child) has no legal rights to the funds so you can be sure that the money will be used for its intended purposes.
You can also change the beneficiary if the original choice doesn’t pursue higher education or receives a scholarship.
There are some exceptions to this rule in regards to custodial accounts under UGMA/UTMA, but for the majority of cases you are in control of the plan.
Unlike other education savings options, a 529 plan provides you with flexibility over the funds. You have the freedom to choose the investment options that align with your risk tolerance and financial goals.
If your child decides not to attend college, you can either transfer the plan to help someone else pay for college or withdraw the funds to use for other expenses.
It’s important to point out though that if you do not use the money for educational expenses, the IRS will charge you income tax and an additional 10% penalty tax on your investment earnings.
529 plans offer unique benefits for estate planning purposes. Contributions are considered gifts to the named beneficiary in the eyes of the government, but deposits up to $17,000 per individual per year qualify for the annual gift tax exclusion.
Just be aware of your contributions if you are making other gifts to the same beneficiary in the same year.
Gift Tax Averaging
As long as you elect to treat the contribution as if it were made over a five-year period, you can make a lumpsum contribution, also called superfunding. This can reduce your taxable estate and potentially minimize estate taxes.
Furthermore, the IRS allows you to contribute up to $75,000 ($150,000 for married couples) in a single year without incurring federal gift tax.
Life insurance protects your family’s future and should you die prematurely, the death benefit can provide funds to help pay for everything they need, including college tuition. Term life insurance is simple, customizable and affordable. Get a term life insurance quote today.