All About 529 Plans
I learned law so well, the day I graduated I sued the college, won the case, and got my tuition back.
— Fred Allen
Here is a consolidated guide to everything I learned about 529 plans so far. I’ll add to it as there are updates/corrections/new information.
What is a 529 Plan?
A 529 Plan is a tax-advantaged savings account. It is to college what Roth IRA is to retirement without all the constraints. 529 Plans are typically administered by states and educational institutions. They are so named after Section 529 of the Internal Revenue Code.
What are the tax advantages?
Like with a Roth IRA, contributions to 529 Plans grow tax free. You don’t have to pay a single dime in taxes as long as you use the money for qualified education expenses. Some states also offer tax deductions for contributions. Here is a list of states and whether or not they give deductions or credits.
What qualify as eligible education institutions?
Accredited colleges, universities, and vocational schools.
What qualify for education expenses?
Housing, tuition, fees, books, supplies, equipment, as required for enrollment or attendence at eligible education institutions, though there are caps on what you can pay to housing.
What are the rules surrounding room and boarding payments?
The beneficiary has to be enrolled at least half-time for housing and boarding to count as qualified expenses. Housing payments are capped at on-campus room and boarding costs. Housing payments qualify up to this cap even if (s)he were to live off-campus.
What about student loans? Do they qualify?
Sort of. Student loans qualify only in the year that they are taken.
What if the beneficiary chooses not to go to college?
You can roll the account over to be a family member of the beneficiary (for free — no fees).
Who are family members?
IRS considers the following people to be a family member:
- Spouse
- Son, daughter, stepchild, foster child, or a descendant of any of them.
- Brother, sister, stepbrother, or stepsister.
- Father or mother or ancestor of either.
- Stepfather or stepmother.
- Son or daughter of a brother or sister.
- Brother or sister of father or mother.
- Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
- The spouse of any individual listed above.
- First cousin.
What if the beneficiary gets a scholarship?
You can withdraw the amount of scholarship from the 529 Plan without having to pay any penalty. However, you will have to pay state and federal taxes on the withdrawal. On the other hand, you can avoid the taxes by transferring the plan to another beneficiary.
How much can you contribute?
It depends on the plan.
How many 529 Plans can you open for a beneficiary?
As many as you want. However, the total amount in all the accounts for the beneficiary cannot exceed the limits sit by the state.
What if I make a non-qualified distribution?
You will have to pay income taxes, as well as a 10% penalty, on the earnings-portion of the distribution except in rare cases (him/her getting a scholarship, being one of them).
Who has control of the money?
You, the donor, do.
How does a 529 Plan affect federal financial aid?
Depends on the beneficiary’s relationship to the donor. A 529 Plan owned by a parent is assessed as a parental asset by FAFSA, while a 529 Plan owned by the student are considered the student’s assets. In both cases, the plan is assessed at a rate of 5.64%. So, generally-speaking, if you have a $25,000 529 Plan for your son, his eligibility for aid may decrease up to a maximum of $25,000 x 5.64% = $1,410.
What are pre-paid tuition plans?
Prepaid tuition plans essentially allow you to purchase tuition at today’s rates. If the beneficiary happens to go to some other college, then the state will pay out to the appropriate college/university; however, because you bought credits, the account value depends on the college’s tuition rates.
What if I make a million dollars a year? Can I still contribute?
Yes. Unlike with a Roth IRA, there are no income limitations on contributions to 529 Plans.
How much can I contribute to a beneficiary per year?
You can contribute up to $12,000 per beneficiary per year or you can make one lump-sun payment of $60,000 (and none for the next five years) without having gift-tax consequences.
Can I use a 529 Plan to pay for K12?
No. Unlike with a Coverdell Education Savings Account (ESA), you can only use a 529 Plan to pay for post-secondary schooling.
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