Besides buying a house, funding a college education might be one of the most expensive things a person chooses to do—whether for themselves or for their children. According to a recent study, the average student loan debt in 2021 was $39,351.1 That means years of payments for hundreds of dollars that could be spent elsewhere—such as starting a business or even a family.
Tuition prices are rising at a rapid rate and can cause financial havoc on future generations that are unprepared for that expense. These days, parents desire to assist their children—and future generations—by finding ways to start them off on the right foot, including through college funding solutions like a 529 plan. A 529 plan is a financial vehicle used by any family member or friend to provide money for tuition and other educational expenses. Enacted in 1996, 529 Plans are named after Section 529(b) of the Internal Revenue Code and are a newer way of funding educational expenses.
Advantages of a 529 Plan
A 529 savings account offers important tax advantages.
- Contributions are made with after-tax money, and the earnings on the contributions accumulate tax free.
- Some states offer tax deductions or tax credits for 529 contributions (benefits and restrictions vary by state).
- The earnings can be withdrawn tax free for qualified expenditures.
- Qualified expenses include college tuition, books, supplies, and room and board. Funds can be used at public and private universities as well as for trade schools and other educational options across the United States, including some international institutions.
- Up to $10,000 per year can also be used for K-12 tuition expenses.
- Any expense not considered qualified is eligible to be taxed and have a 10% penalty applied to it.
In addition, anyone with a social security number, irrespective of income, can open and contribute to a 529 plan for any beneficiary. The beneficiary can also be changed if the intended child does not go to school or does not need the funds for some reason, such as scholarships or financial aid received.
Most plans have lifetime contribution limits of $350,000 or more, depending on the state. This is helpful when you consider the increasing cost of college education.
- If you start when the child is young, contributing even just a small amount each year can add up over time.
- There is also new legislation, beginning in 2024 as part of the SECURE 2.0 Act, that states that have an overfunded 529 account may possibly be moved into a Roth Individual Retirement Account (IRA) for the beneficiary of the 529.
- This would decrease the concerns of overfunding a 529 account and being penalized for withdrawing. Note that the 529 conversion to a Roth IRA has a lifetime limit of $35,000 and the 529 must have been in place for at least 15 years (among other requirements).
- Contributions are considered gifts for gift and estate tax purposes and will reduce the contributor’s taxable estate.
- Gifts of greater than $17,000 per year ($34,000 for a couple) are subject to gift tax, although a lump sum gift of up to five times the annual limit can be made without gift tax if the gift is treated as having been made in equal installments over five years and no additional gifts are made to that beneficiary in those five years.
- This can be a terrific way for grandparents to gift money to the grandchild at an accelerated rate and pare down their estates.
Investment options can be chosen by a professional financial advisor from available options but are often self-directed. Target date funds are commonly used. With any investment there is risk, but these investments typically consider the beneficiaries' age to determine risk tolerance and adjust this as needed.
Types of 529 Plans
There are two basic forms of the plan:
- Savings Plans | A typical 529 plan, which allows you to save money for the beneficiary of the plan for use at any school in the future. These funds, which will accumulate over time, are to be allocated for college-related expenses (or K-12 expenses, with certain limitations).
- Prepaid Tuition Plans | These plans allow you to prepay tuition in today’s dollars for the use of a student at a future time. Plans may be offered by states or universities, and some restrictions will apply. This type of 529 plan is less commonly used but can be an excellent solution in certain circumstances.
If college is on the horizon for your family, you may want to consider a 529 Plan. As always, the sooner you begin planning, the better prepared you will be. We also recommend talking to your financial advisors to see if a 529 Plan is a viable option based on your unique situation.
The financial professionals at Busey Wealth Management are here to help you prepare for the future—whether you’re planning for today or the years to come. To learn more about our comprehensive services or find an advisor near you, visit busey.com/wealth-management.
1 thecollegeinvestor.com, Average Student Loan Debt By Year (Graduating Class)
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.
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