A 529 plan can be a great tax-advantaged way to save for college for your children. Having a 529 plan can make it affordable and convenient to start saving early on. This can make a huge difference in the financial future of your children. Let’s talk about 9 benefits of a 529 plan and why this might be right for you and your family.
What is a 529 college savings plan?
A 529 plan allows you to save for education. You add funds into the 529 account, and then you invest those funds to allow them to grow in the years prior to needing that money. When you withdraw that money for a qualified education expense, the growth of the account comes out tax-free. There are many benefits to 529 plans, so let’s get into those now.
1. Tax benefits
529 plans come with federal tax benefits, and some state tax benefits (depending on your state). The federal benefits come from the gains in a 529 plan not being taxed when they’re used for qualified educational expenses. For example, if you contribute every year into your child’s 529 plan for 18 years, and invest that money for all 18 years, a good portion of that account would likely be made up of growth. The gains on this account would come out completely tax-free when used for qualified education expenses.
Many states also give tax deductions on your state tax return in the years that you contribute to the 529 plan. So you’re getting the state tax deduction now, and a federal tax break later.
2. 529 plans are low maintenance
Investing in a 529 plan is actually quite simple. Most plans have age-based investment choices that will invest based on the age of the child, or the time horizon until the money is going to be withdrawn, as well as risk tolerance. This will automatically make your investments more aggressive in the beginning and less aggressive the closer it gets to the time of withdrawal. Alternatively, you can choose individual funds if you don’t like the age-based funds. The age-based funds make it low maintenance because the investments will adjust on their own, but it can be too aggressive for some people.
6. No income limits
Unlike many other education benefits that provide tax advantages, such as a Coverdell, ESA, and certain education tax deductions and credits, 529 plans do not have income limits. Regardless of your income, you can take advantage of the federal tax benefits a 529 plan provides.
7. You stay in control
Unlike a savings account like a UGMA or UTMA, where the money becomes the child’s rightful property at age 18, 529 stays in the name and control of the owner, not the beneficiary. Often this is a grandparent or parent. For example, if you open a 529 for your first child, and your first child turns 18 and decides not to go to college, you do not have to turn this money over to them. The account is still in your name and you are still the owner. You can change the beneficiary of this account to yourself, another family member, or another child. There’s flexibility in who can receive the benefits of this account.
8. 529 plans won’t disqualify students from financial aid
The 529 plan stays in the parents’ names and not in the child’s name. This means that the calculations used in the federal aid formula are much more favorable than using a savings or brokerage account that transfers assets to the child. See the Federal Student Aid website for more information on calculating these assets.
9. 529 state tax deductions/investment
Knowing that each 529 Plan is different, how do you decide which to use? Do you simply choose the plan that belongs to your state? That answer depends on two questions: One, does your resident state offer tax deductions for 529 contributions? And two, does your plan offer low-fee investment fund options?
If your state offers both of these, it’s an easy decision. Go with your state 529. If your state offers neither one of these, or your state has no income taxes and the plan choices aren’t great, you may want to choose a plan from another state. While this won’t allow you to take a state tax deduction from another state, you can take advantage of low-fee investment choices.
Take a look at the chart below to determine what benefits your state 529 plan has.
529 state tax deductions/investment
|State||State Tax Deduction Offered||Low Fee Investment Choices Available*|
|Alaska||No State Income Tax||✓|
|Florida||No State Income Tax||✓|
|Nevada||No State Income Tax||X|
|New Hampshire||No State Income Tax||✓|
|South Dakota||No State Income Tax||✓|
|Tennessee||No State Income Tax||✓|
|Texas||No State Income Tax||✓|
|Washington||No State Income Tax||X|
|West Virginia||✓||X (Smart 529 Select) |
✓ (Smart529 Direct)
|Wyoming||No State Income Tax||X|
Is a 529 plan right for you and your family?
A 529 plan can be a great way to save for your children’s college early on. You can take advantage of compound interest and all of the benefits we outlined above. If you are interested in having a comprehensive financial plan for your family, including creating a 529 plan for your child, schedule a free discovery call with one of our financial advisors today.
Shanna Due, AFC® is a fee-only financial planner based in Williamsburg, Virginia. She uses her Master’s degree from the University of Northern Colorado, her certifications, and two decades of experience to help professionals in their 30s and 40s achieve their financial goals. She does this through goal-oriented savings and investing, reducing taxes, planning for retirement, and mitigating risk. To find out how she and the team of District Capital Management can help you schedule a free discovery call.