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A 529 Plan Might be a Great Way to Grow your College Savings and Save on Taxes

A 529 Plan Might be a Great Way to Grow your College Savings and Save on Taxes

June 21, 2021

The COVID-19 pandemic has affected families’ finances in many ways. One negative impact for some families has been a disruption in their well-laid college savings plans.

The economic crush of the pandemic may have put saving for your child’s college education on the back burner, at least for the short term. If you can’t fully fund your kids’ education savings plans yet, it’s wise to continue putting something away for college if you can — even if it’s less than before.

Consider a 529 plan

A Section 529 plan remains one of the best ways for families to save money for college while saving on taxes at the same time. Earnings in the account grow on a tax-deferred basis and distributions are tax-free if the funds are used to pay for qualified education expenses. The definition of these expenses is quite broad and includes not just tuition and fees but also books, room and board, school supplies, technology (such as a computer and printer), and Internet access.

All 50 states and the District of Columbia offer at least one 529 plan, and you don’t have to live in a state to open a plan there. Students don’t have to attend college in the state where their 529 plan is opened, either.

The main types of 529 plans are:

Prepaid tuition plans. These plans enable you to purchase future tuition at today’s prices, giving you more certainty about future education expenses. For example, you could purchase four years of college for a newborn now at today’s tuition rate, potentially saving tens of thousands of dollars in the long run.

Investment savings plans. These are similar to retirement savings accounts like IRAs and 401(k)s. You can invest your college savings in stocks, bonds and other instruments to try to maximize returns, and your account balance will rise or fall depending on the performance of your investments. Of course, this would potentially put your college savings at varied degrees of risk.

Section 529 plan funds can be used to pay for qualified education expenses at most U.S. colleges and universities as well as some schools located overseas and many vocational-technical schools. This enables you to choose the best plan for your family and not worry about limiting college options in the future.

Rules of the plan

Unlike qualified retirement plans, there are no annual limits on contributions to 529 plans, though there are limits on aggregate contributions. These vary by state but can exceed $500,000. Plan contributions can be made by other family members, too, including grandparents if they want to help with your children’s college expenses. And there are no income limits for opening and contributing to a 529 plan.

Note that contributions to 529 plans aren’t tax-deductible at the federal level, though some states offer a deduction or other tax incentives for contributing. If plan funds are used for anything other than qualified education expenses such as those listed above, the earnings portion of the withdrawals only (not principal) will be subject to current income taxes and a 10% penalty.

Get creative

If the pandemic has made it difficult for you to save for college, one idea is to contribute the amount of your stimulus payment (if you received one) to college savings if you can afford to do so. Similarly, you could take the same action with your increased child tax credit if you qualify for this.

Speak with one of our CPAs or financial advisors about the tax implications of 529 plans and the most appropriate financial and college saving strategies for your family.

© 2021