What is a 529 Education Savings Plan? | Kiowa County Press

A 529 plan can pay up to $10,000 per year for tuition at K-12 schools. MoMo Productions/DigitalVision via Getty Images

Robert H. Scott III, Monmouth University

The college savings plan known as “529” is often touted as a smart way to save for a child’s college education. But these plans involve more than just setting aside money for college. Right here, Robert H. Scott IIIa expert in 529sheds light on how the plans work.

What are 529 plans?

A 529 College Savings Plan is an investment account that families can open to save for college by investing money that grows tax-free. The account name comes from Section 529 of the US tax code.

The money can be used for eligible education expensessuch as tuition, room and board, textbooks, computers and travel.

People can add money to a 529 account whenever they want or set up automatic withdrawals from their checking account.

At the end of 2020, the Americans had invested a total of 425 billion US dollars in 529 shots. In 2020, the average 529 plan had $25,644but average sales vary according to the age of the child. This amount corresponds almost exactly to the total cost of a single year at a four-year in-state college. The average total cost of a year in a private school is more than double that amount.

When money is placed in a 529, it’s not like the money stays there. You will have several possible investment options to choose from which include stocks, bonds or a combination of both. There are usually predefined investment portfolios based on the age of the child. When a child is young, these portfolios are primarily stocks and are invested more aggressively. But as the child gets older, the wallet automatically transfers more money to bonds, which are generally less volatile. Thus, the effectiveness of a 529 plan depends on the performance of the stock market.

Is the money only for the first four years of college?

It is also possible to use 529 plans for higher education. So if a child earns a full scholarship as an undergraduate student, the money from the child’s 529 plan can be saved for their higher education.

A recent change in 529 plans allows them to be used for education before college. Specifically, they can be used to pay up to $10,000 per year for tuition at K-12 schools.

For college, however, there are no limits on the amount that can be withdrawn to cover educational expenses.

Do 529 plans vary by state?

Every state in the United States, plus Washington, DC, has its own 529 plan. However, not all plans are the same. For this reason, it’s important to research which plans have the lowest fees, the best investment options, and the better overall yields.

There are no residency requirements. In other words, you don’t have to live in a particular state to invest in the state’s 529 plan. However, if a state offers a tax deduction for investing in its 529 plan, then you must live in that state to qualify for the deduction.

What if the beneficiary of the 529 does not go to university?

It is possible to transfer funds in 529 plan accounts from one beneficiary to another. Beneficiaries who don’t use their 529 plan funds can even transfer the account to their own children or another family member without penalty.

The biggest problem with 529 plans is that money not used for qualified education expenses carries a 10% penalty on investment earnings. This income is also subject to federal and sometimes state income tax if it is not used for eligible education expenses under a 529 plan.

Who should invest in 529 plans?

Families unable to qualify for financial aid are the target investors for 529 plans.

A 529 plan account with a large balance could prevent a student from being eligible for financial aid, even if the balance is well below the overall cost of the degree. So in cases like this, a 529 plan could be costing families money rather than helping them.

Grandparents whose grandchildren are unlikely to qualify for financial assistance are also common investors in 529 shots.

Parents, grandparents or anyone with the ability and desire can contribute up to $16,000 a year if a child’s parents are unmarried – or $32,000 if they are married – and not pay gift tax. People can contribute up to this maximum amount each year for each beneficiary. So if a grandparent has two grandchildren whose parents are married, they can contribute $32,000 in one year to each child’s 529 plan.

Each state has different rules on how much a person can contribute over their lifetime to a 529 plan, but It’s okay from $235,000 in states like Georgia and Mississippi to $550,000 in Missouri.

Do 529 plans work?

Yes. It is a way for families to invest money in the stock market and, if all goes well, to benefit from financial gains that they can withdraw for the education of their children without paying taxes. They work best in several conditions.

First, if a family is ineligible for financial aid, 529 plans offer an effective way to save for college because the money is invested in the stock market and can grow faster than other options, such as accounts. savings. Also, the gains are not taxed as they would be if invested in an investment account other than the 529 plan.

Second, because the investment time horizon is short – perhaps less than 18 years – your money doesn’t have much time to grow, so you need to invest early. There is no age limit for beneficiaries of 529s. You can start one for yourself or for someone else at any age.

Third, if you live in one of the states that offer a tax deduction for investing in a 529 plan, this is a factor to consider. Specifically, a 529 holder should consider whether the value of the tax deduction is large enough to compensate for the fact that there are fewer or fewer investment options.

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Fourth, anyone can contribute to someone’s 529 plan, so it’s a great gift that won’t end up being broken or thrown away.

Fifth, grandparents or other relatives, and even family friends, can make 529 plans for grandchildren, stepchildren, nieces and nephews. In general, it’s probably more efficient to have one 529 plan, but some people like to keep some control over which plan they invest in, so some kids may have more than one. For example, I have 529 plans for my two children, but their grandparents also have 529 plan accounts for them.

There are other situations which allow you to withdraw funds from the 529 plan and not be subject to the 10% penalty, such as when a beneficiary dies, becomes disabled, or wins a full scholarship. Relatives could find this type of savings more emotionally rewarding than to give money now or to give a larger inheritance in death.

Are there any disadvantages?

There are two main problems with 529 plans, even for the families that might benefit the most.

First, the timing of withdrawing money is more difficult than, say, retirement. For example, if the market is in a down year, but a beneficiary is in college and you have to pay tuition, the benefits may be smaller overall. Suppose you invested $50,000 in a 529 plan and the market fell 10% just before you withdrew the money. If this happens, then you will only have $45,000 to withdraw. On the other hand, if the market rose 10% just before you needed the money, then you would have $55,000 to withdraw.

Second, your investment options are limited. If your state offers a tax deduction for investing in a 529 plan, you can choose to invest in your state’s plan even though that plan might not be very good, like it has high fees. Alternatively, you can choose to invest in another state’s 529 plan and lose the state tax deduction, but have more investment options and fewer fees. It could save you more money in the long run.

The conversation

Robert H. Scott IIIProfessor, Department of Economics, Finance and Real Estate, Monmouth University

This article is republished from The conversation under Creative Commons license. Read it original article.

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