Paying for college may be a challenge given the rising costs of tuition. A 529 plan may help you save more money for college when the time comes.
What is a 529?
A Section 529 plan is an education savings plan sponsored by a state and operated by a state, educational or financial institution, designed to help families set aside funds for education costs. In the same way, a 401(k) or Roth IRA is designed to offer tax advantages to help you save for retirement, 529 plans were created to help save for a college education. As of January 1, 2018, for federal tax purposes, “education” includes elementary and high school tuition, not just postsecondary education.
Although 529 plan contributions are not deductible on your federal tax return, your investment can grow tax-deferred, and distributions to pay for qualified education expenses for the named beneficiary come out free of federal income tax. In addition to the federal tax savings, more than 30 states currently offer a full or partial tax deduction or credit for 529 plan contributions. Be sure to research all of your options.
529 plans offer additional benefits beyond tax breaks. Unlike a UGMA/UTMA, where the child takes control of assets once legal age is reached, the 529 account owner maintains control of the account. There are also no income, age or annual contribution limits for 529 plans unlike Roth IRAs or Coverdell Education Savings Accounts (there are lifetime contribution limits for 529, which vary by plan and state, ranging from $235,000 to over $500,000).
What are qualified education expenses?
- Tuition—Tuition is a qualified expense for both full- and part-time students at any eligible educational institution in the country or abroad. An eligible educational institution is one eligible to participate in federal financial aid programs.
- Room and board—If the student is attending school half-time or more, and the room and board are paid directly to the institution, this is a qualified expense. For students living off campus, the amount of room and board expenses that may be treated as a qualified expense is generally limited to the room and board allowance included by the eligible educational institution in its “cost of attendance” for purposes of determining eligibility for federal education assistance for that year.
- Books and supplies—Books and supplies are qualified expenses, but only the ones that are required.
- Computers and related technology expenses
- K-12 school tuition, up to $10,000 annually per student from all 529 plans.1
The SECURE Act (Setting Every Community Up for Retirement Enhancement Act) added education expenses required for participation in certified and registered apprenticeship programs and the repayment of student loans as a qualified education expense. Up to $10,000 may be used from a 529 plan to repay the student loan principal or interest of either a 529 plan designated beneficiary or a sibling of the designated beneficiary. To be a qualified expense, the loan repayment amount for an individual is subject to a lifetime limit of $10,000.2
If you withdraw 529 plan funds and do not use them for qualified education expenses, there is a 10% penalty, and federal income taxes are due on the investment earnings. There are exceptions to the 10% penalty such as death, disability, or receipt of a scholarship but taxes on the growth will still be due. You can also transfer the funds to another eligible family member, which allows for flexibility if the intended beneficiary does not use the funds.3
Questions? Call 1-800-544-5248.
1Withdrawals for tuition expenses at a public, private or religious elementary, middle, or high school can be withdrawn free from federal tax. For California taxpayers, these withdrawals are subject to state income tax and an additional 2.5% California tax. You should talk to your qualified professional about how tax provisions affect your circumstances.
2Withdrawals for registered apprenticeship programs and student loans can be withdrawn free from federal and California income tax. If you are not a California taxpayer, these withdrawals may include recapture of tax deduction, state income tax as well as penalties. You should talk to a qualified professional about how tax provisions affect your circumstances.
3See the ScholarShare 529 Plan Description for allowable family members.