529 plans have emerged as a popular and effective tool for saving for education expenses. These tax-advantaged savings plans offer significant benefits that make them a wise choice for parents or other family members who are looking to secure a loved one’s education future.
These plans are not just for college and graduate school, but also for K-12 tuition, trade school, and student loans.
Tax Benefits:
One of the most compelling reasons to consider a 529 plan is the tax advantages it offers. Contributions to 529 plans don't receive a federal tax deduction, but many states provide a state income tax deduction for contributions made to a 529 plan. Additionally, the earnings and withdrawals from the plan are both federal and state tax-free when used for qualified education expenses. This includes tuition, fees, books, and supplies for undergraduate and graduate programs.
Flexibility and Growth:
529 plans offer flexibility in terms of investment options. You can choose from a variety of investment strategies, including age-based, target-date, and actively managed funds. This allows you to tailor your investments to your risk tolerance and time horizon. The earnings on your 529 plan investments grow tax-deferred, potentially leading to significant savings over time.
Gift Tax Considerations:
529 plans also provide a valuable gifting strategy. As an individual donor, you can contribute up to the annual gift tax exclusion amount ($18,000 in 2024) per beneficiary per year without incurring gift tax. To contribute more, a donor can gift up to 5 years’ worth of contributions at once to a 529 account in a single year without it counting against the donor’s lifetime gift tax exemption. In other words, in 2024, an individual donor can contribute up to $90,000 to a specific 529 plan. In this case, the donor couldn’t give more money to that same recipient within the 5-year period without counting against the lifetime gift tax exemption.
Overfunding a 529 Plan:
Setting up a 529 plan early in a beneficiary’s life is often a smart decision, but overfunding the account is always a risk. For example, the account beneficiary may not choose to continue education past high school, he or she could receive scholarships and aid to fund most of the schooling, or perhaps donors have contributed too much to the account.
If the account is overfunded, it can always be passed on tax and penalty free to another family member or up to $35,000 can be rolled into a Roth IRA in the beneficiary’s name. The $35,000 Roth contribution is new in 2024 and requires 529 plans to have been open for 15 years. Additionally, transfers to Roth IRAs are counted as contributions, so transferring the $35,000 will take several years. Nevertheless, this is a significant change and provides future benefits beyond education.
Conclusion:
529 plans offer a powerful and flexible way to save for education expenses. The tax benefits, state-specific incentives, investment options, and gifting strategies make them a compelling choice for parents, guardians, and other family members. By starting early and taking advantage of the benefits offered by 529 plans, you can help ensure that the beneficiary has the financial resources they need to pursue their educational goals. Please reach out to one of our advisors if you would like to learn more about the benefits of setting up a 529 plan.
Prior to investing in a 529 Plan investors should consider whether the investor's or designated 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. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
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