529 plans and their tax benefits

With the costs of college and other post-secondary education continually rising, clients often ask about effective methods of planning for their children’s future education costs.

Though there are several methods of planning for future education costs, one popular technique is to use a 529 plan.

What is a 529 plan?  Simply put, a 529 plan is a college savings plan that offers tax and financial aid benefits.

What types of 529 plans are available?  There are two types of 529 plans: College Savings Plans and Prepaid Tuition Plans.  College Savings Plans invest your after-tax contributions in investments much like a Roth 401(k) or Roth IRA.  Prepaid tuition plans allow you to pre-pay all or part of the costs of an in-state public college education.  It can also be converted for use at private or out-of-state colleges.

How can a 529 plan be used?  A 529 plan allows tax-free earnings growth and tax-free withdrawals of funds when the funds are used to pay for qualified education expenses (including trade school) such as tuition, fees, books, supplies, equipment, computers, some room and board, and certain other expenses.  Tax-free withdrawals of up to $10,000 per year per beneficiary can be used to pay tuition at private, public and religious K-12 schools.

Are 529 plan contributions tax-deductible?  Contributions to a 529 plan are not deductible for federal income tax purposes.  However, more than 30 states and the District of Columbia offer deductions or credits for contributions to 529 plans.

What happens to unused money in a 529 plan?  If funds in a 529 plan are not used by the beneficiary, there are still options to avoid paying taxes and penalties on earnings.  These include changing the beneficiary to another family member, holding the funds in the event the beneficiary needs them later, making oneself the beneficiary and furthering your own education, rolling funds over to a 529 ABLE account specifically designed for people living with disabilities, or taking tax-free withdrawals for K-12 tuition.

Obviously, there is much more detail to consider before opening a 529 account, but hopefully, this provides a starting point for the discussion you might want to have with your tax professional or financial advisor.

How to Stack Education Savings

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