Despite the rising price of a bachelor’s degree, parents and families still believe a college education is key to a successful career and comfortable life. And the data supports that mindset; the Association of Public & Land Grant Universities (APLU) reported that the annual median earnings for those with college degrees is 67% higher than the earnings of those with high school diplomas.
A 529 college savings plan can be a valuable tool for families looking to help their children with the cost of a college degree. However, some people put off opening an account because they have questions like, “What can a 529 be used for?” or “Does a 529 plan affect financial aid?”
Continue reading to learn the ins and outs of these important tools.
What Is a 529 College Savings Plan?
When it comes to saving for higher education, 529 college savings plans are popular tools. According to the College Savings Plans Network (CSPN), there were over 16 million 529 savings accounts open as of the end of 2023, with over $450 billion in assets saved.
But what is a 529 college saving plan, and why are they so useful? To understand how they work, the first thing to know is that there are two main types:
Prepaid Tuition Plan
A prepaid tuition plan is available in most states. With this version of 529 plans, you purchase credits or units at participating colleges at today’s rates, and the child can use them to pay for their education in the future.
Education Savings Plan
A 529 education savings plan, also known as a qualified tuition plan, is the better-known of the two options; it’s an investment account that allows family members to contribute money with the goal of growing it over time to pay for the education of a designated beneficiary — usually a child or grandchild — education. By investing in mutual funds, exchange-traded funds (ETFs) or bonds, the 529 plan can grow tax-free, and withdrawals for eligible education-related expenses are free from income taxes.
What Can a 529 Plan Be Used For?
The CSPN reported that families saved an average of $27,741 in their 529 accounts. That’s a substantial amount of money, but, due to the rules governing these accounts, the money can only be used for certain expenses without incurring costly penalties and taxes.
Eligible expenses include:
- Tuition and school-required fees
- Books, supplies and equipment needed for classes, such as computers or software
- Room and board if the student is living on campus (or the allowable living expenses cost as certified by the college)
In addition to college-related expenses, families can withdraw up to $10,000 to pay for private elementary or secondary school tuition.
What Expenses Are Not Qualified Under a 529 Plan?
Although 529 college plans can pay for a broad range of expenses, there are some restrictions. Non-qualifying expenses include:
- Gaming consoles or software for hobbies
- Sports equipment
- Travel costs
- Transportation or car insurance
- Smartphones or tablets not required for classwork
Withdrawals used for non-eligible expenses are taxable as income. And, you’ll incur an added 10% penalty.
Frequently Asked Questions About 529 Plans
1. What happens to a 529 plan if my child doesn’t go to college?
If the selected beneficiary decides against going to college, there are a few options for the money in the account:
- Pay for apprenticeship programs: If the beneficiary elects to participate in an apprenticeship program to learn a trade, 529 funds can be used to pay for their fees, books, supplies and other necessary equipment.
- Transfer to another beneficiary: The 529 plan can be transferred to another beneficiary to pay for their education. For example, you can change the beneficiary to a sibling or another relative.
- Repay student loans: Thanks to new regulations, families can use up to $10,000 to pay off student loans belonging to the beneficiary or the beneficiary’s sibling.
- Roll into a Roth IRA: As of 2024, families have the option of rolling up to $35,000 into a Individual Retirement Account (IRA) in the beneficiary’s name. With this approach, you can avoid paying ordinary income taxes or penalties, but the beneficiary must have earned income.
- Withdraw the cash: If you don’t have another family member who could benefit from the 529 plan, you could withdraw the cash and use it as you wish. Just keep in mind that the withdrawal will be taxed as ordinary income, and there will be an additional 10% penalty.
2. Does a 529 plan affect financial aid?
The assets in a 529 plan are considered in the federal student aid formulas. However, 529 plans are considered parental assets, so the maximum rate is 5.6%, meaning only 5.6% of the 529 account balance is included in the calculation. That’s quite different from student assets, which are calculated at a maximum rate of 20%.
3. Am I eligible for a tax credit or deduction for contributing to a 529 plan?
Contributions to 529 plans aren’t eligible for federal tax credits or deductions, but you might qualify for special tax benefits at the state level.
For example, the following states offer tax benefits for contributing to a 529 plan:
- Georgia: If you’re single, you can deduct up to $4,000 per year, per beneficiary, on your state income tax return. For couples filing jointly, the maximum is $8,000 per year per beneficiary.
- New York: New York residents can qualify for a tax deduction as high as $5,000 for single filers ($10,000 for those who are married and filing a joint return).
- Oregon: Oregon provides taxpayers with a tax credit of up to $170 ($340 if they’re married filing a joint return) if they contribute to an Oregon 529 College Savings Network plan.
Morningstar, an investment research company, maintains a list of available state tax deductions and credits.
