It’s never been more important to save for college, as tuition continues to rise – and rise. One way people have saved for their children’s tuition has been through 529 savings plans.
If you have a 529 savings plan or have thought about starting one, here’s what you need to know.
What is a 529 savings plan?
A 529 savings plan is a state-originated tax-benefitted education savings program that lets you either prepay tuition or contribute to an investment account to save for future tuition, fees, equipment, and room and board. 529 plans are also called Qualified Tuition Programs (QTPs).
As the contributor, you make contributions to the tax-advantaged investment account or prepaid tuition account for a designated beneficiary. You don’t get a tax deduction when you make the contributions. However, when the money is taken out for qualifying expenses, the beneficiary does not pay tax on the proceeds.
The pre-paid tuition plans may be administered by the states or the higher education institutions. The savings plans are administered by states.
Who qualifies to open a 529 savings plan?
A contributor can open an account for a beneficiary. Plans are typically opened by parents or grandparents, although a person age 18 or older can open his or her own 529 plan if they choose. Even friends and other interested persons can open an account for a beneficiary. There are no income limitations for contributors to 529 plans.
Not all states and higher education institutions participate in 529 plans or accept new applicants. Contact your state or educational institution to find out if they do. You can also open a plan in a state other than the one where you live.
Can I change the beneficiary of a 529 savings plan?
As the contributor, you still have control of the account, and you can change the beneficiary up to one time per year. You may want to do this if the original beneficiary doesn’t go to college, for example, or passes away. You can even change the beneficiary to yourself, if you want, as long as you use the proceeds for education expenses.
How did tax reform impact 529 savings plans?
Prior to the Tax Cuts and Jobs Act of 2017, Federal tax rules only allowed you to use 529 plans to pay for post-secondary tuition, fees, books, supplies, and equipment. (Room and board expenses were included if the student attended at least half time.)
Starting in 2018, you can use up to $10,000 per year from a 529 plan to pay qualified expenses for elementary and secondary education.
How does a 529 plan differ from a Coverdell ESA?
You can also pay for elementary and secondary education expenses using a Coverdell ESA. However, the 529 plans have some advantages.
The Coverdell ESA has a small contribution limit ($2,000 per student). A 529 plan has no contribution limit. You cannot contribute to a Coverdell ESA if your income is too high or after the beneficiary reaches age 18. The 529 plans do not have those restrictions.
Do the changes impact 529 savings plans that were already open?
Yes, you can withdraw up to $10,000 per year from an existing 529 plan to pay for elementary and secondary education expenses. That option was not available before the Tax Cuts and Jobs Act when into effect.
How did the new tax law affect 529 plans and children with disabilities?
You can now roll over an existing 529 savings plans into a 529 ABLE account for disabled individuals. An ABLE account is similar to a 529 plan, but it can be used not only for college, but also for expenses including job training, healthcare, and financial management.
Prior to the tax law changes, taking a distribution from a 529 plan to pay for expenses other than higher education would have resulted in income tax and a 10 percent penalty on the earning portion.