529 Savings Plans: Investing Toward College & More

529 Savings Plans: Investing Toward College & More

Key Takeaways

    Growth in a 529 plan is federally tax deferred

    You can contribute $75,000 all at once without paying the gift tax

    These accounts can help pay for elementary, high school, or college

When you think of investment accounts, an education savings plan may not be the first thing that comes to mind. But if you want to help family, friends, or even yourself pay for learning, you might consider adding a 529 plan to your financial playbook and tax strategy.

529 savings accounts can be used in some states for primary education, but mostly they should be used for college. According to the College Board, published in-state tuition and fees at public four-year institutions rose an average 3.1% a year beyond inflation between 2008–09 and 2018–19.

Enter the 529 savings plan. According to the rules, funds from these tax-advantaged investment accounts can be used for a beneficiary’s qualified education expenses such as “tuition, fees, books, as well as room and board at an eligible education institution and tuition at elementary or secondary schools,” according to the IRS. 

While 529s can be useful for investing toward education expenses for family or friends, you can also use them to invest toward your own education. Perhaps a 529 plan could be useful for those who say to themselves, “When I retire, I want to go back and live my dream,” said Dara Luber, senior manager of retirement for TD Ameritrade.

Potential 529 Account Benefits

    Tax advantages: In addition to growth being federally tax deferred, qualified withdrawals are free from federal tax and generally not subject to state tax. Contributions aren’t deductible on your federal taxes, but some states offer benefits for in-state residents using the state 529 savings plan, usually in the form of making contributions tax deductible. Compare that with withdrawals from a brokerage account, where you’ll likely have to pay capital gains taxes on any earnings.Avoiding the gift tax: Another key advantage of 529 education funds is that they can expand what you can give to a loved one in a lump sum without paying a gift tax. In 2018 and 2019, you can’t give someone (other than your spouse) more than $15,000 without paying a federal gift tax. But with a 529, you can contribute as much as $75,000 in a single year without paying a federal gift tax (and up to $150,000 for married couples filing jointly). This is achieved by counting future gifts in the current year. For example, the $75,000 gift counts for $15,000 in the current year and four annual gifts of $15,000 in future years.Fund flexibility and security: Another nifty feature of a 529 savings plan is that you can change the beneficiary within the family if you end up having extra in the fund. Or, if Junior turns out to be a promising rocket scientist (or a star athlete) and happens to land a scholarship, you can withdraw money from the 529 plan, without penalty, up to the level of the scholarship. Your withdrawal will still be subject to taxes on earnings, but you won’t have to pay the 10% penalty for nonqualified withdrawals. Also, 529s are maintained by the account owner. So, as Luber noted, your kid can’t run off to Europe with your money. But if the beneficiary decides not to apply the money to qualified expenses—say, if they decide to not go to college—then you’ll incur the 10% penalty for withdrawing the money. But remember, you can transfer it to another member of the beneficiary’s family to avoid that.

Work toward a degree—and some potential tax savings.

A Balancing Act

Of course, you also have to think about your own future, which may mean saving for retirement. You’ll have to balance that need versus wanting to invest toward someone else’s education.

When thinking about a savings hierarchy, Luber said people may want to consider socking away money into a 529 savings plan after they have established an emergency fund, are meeting their own goals for retirement, and have paid down non-mortgage debt such as credit cards and their own student loans.

“You should consider setting aside money for retirement first,” she said. “You cannot take a loan for retirement; you can take a loan for college.”

It’s not just parents that can save for their kids’ college, she noted. Children can also get scholarships or grants and be part of work-study programs. Less-expensive in-state schools can be an option.

And it’s important to set children’s expectations and not let them think you’ll pay for all their education if you can’t afford it, she said.

“You have to balance it out so that you’ve got your own future set,” she said.

An investor should consider a 529 plan’s investment objectives, risks, charges and expenses before investing.  A plan’s Program Disclosure Statement, which contains this and more information, should be read carefully before investing. 

Investors should consider before investing whether their or their beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program and should consult their tax advisor, attorney and/or other advisor regarding their specific legal, investment or tax situation.

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