What is a 529 Plan?

​A 529 Plan is a tax-advantaged savings plan to be used for education expenses. 529 Plans are operated by state and educational institutions designed to incentivize saving for college and other post-secondary schooling.

There are two types of 529 Plans: Prepaid Tuition Plans and Education Savings Plans.

Prepaid Tuition Plans vs. Education Savings Plans
Prepaid Tuition Plans allow savers to pre-pay for tuition at specific colleges and universities. The main benefit of these plans is they allow account holders to lock-in today's tuition rates for future schooling of the beneficiary. In other words, if you purchase one unit/credit of schooling at today's rates, it pays for one unit/credit of future schooling, regardless of any changes in cost over time. Room and board is generally not a part of Prepaid Tuition Plans.

Education Savings Plans allow savers to open an investment account to save for a beneficiary's future education expenses. These expenses include tuition, required education fees, as well as room and board. Withdrawals from these accounts have historically been authorized for use at colleges and universities. But with recent tax reform, these accounts can now be used to pay up to $10,000 per year per beneficiary for tuition at any public, private, or religious elementary/secondary school. Education Savings Plans offer more investment and schooling flexibility verses Prepaid Tuition Plans.

What are the Tax Implications?
Contributions to 529 Plans are generally made with post-tax dollars. Earnings then grow tax-free and all distributions are tax-free, assuming the account is used for qualified education expenses, as defined earlier. If not used for qualified education expenses, earnings on the account are subject to taxation, while contributions can be taken tax-free.

While the IRS doesn't allow a tax deduction for contributions to these accounts, several states allow a deduction on the state tax return. California, unfortunately, is not one of them.

Other Considerations
Funding 529 Plans does bring gift taxes in to play. However, these plans provide favorable provisions, allowing for an accelerated gift option that provides savers to surpass standard gift tax rules.

This accelerated option allows you to average gifts exceeding the annual $18,000 exclusion per beneficiary ($36,000 for married couples) over a five-year period, without incurring federal gift tax.

So an individual can contribute up to $90,000 per beneficiary, and a couple can contribute up to $180,000 per beneficiary without incurring gift tax. If you give the full amount, you will not be able to give any gifts to the same individual during the five-year period without incurring gift tax or using up a part of your lifetime exclusion.

Contact us if you'd like an introduction to a provider who can help setup your 529 Plan.

Updated 1/22/2024