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10 Benefits of 529 Plans

Like anything else, 529 plans have their pros and cons, but they offer fairly significant advantages, particularly when it comes to your tax return. Here are the top 10 benefits of 529 plans that you should know about.

1. 529 Plans Offer Unsurpassed Income Tax Breaks

Although a contribution to a 529 plan is not an income tax deduction, earnings in a 529 plan grow federal tax-free and are not taxed when you withdraw the money to pay for certain college and other qualified education expenses.

While many parents plan to use 529 money for college, these funds can help pay for other education expenses, too. Tax-free withdrawals may include up to $10,000 in tuition expenses for private, public, or religious elementary and secondary schools (per year, per beneficiary). You can also withdraw up to $10,000 for student loan payments (per beneficiary and per sibling and step-sibling of the beneficiary, lifetime). The costs of apprenticeship programs are also now considered qualified education expenses, so you can take 529 funds tax free to put toward these programs.

The tax advantages of 529 plans, which were made permanent in the Pension Protection Act of 2006, have incentivized Americans to sock away money for their kids’ — or their own — education.

2. Your Own State may Offer Tax Breaks

In addition to the 529 federal tax benefits, over 30 states and the District of Columbia currently offer a full or partial tax deduction or a tax credit for 529 plan contributions. In some cases, then, 529 contributions reduce taxable income as far as your state taxes are concerned.

You can generally claim state income tax benefits each year you contribute to your 529 plan, so it’s a smart idea to continue making deposits until you’ve paid your last tuition bill.

Be sure to research all of your 529 plan options. Remember that you don’t have to use your home state’s 529 plan. If your state benefits are lacking, you can choose another state’s plan.

3. You’ll Benefit from High Contribution Limits

Unlike some other types of tax-advantaged savings plans, 529 plans have high maximum aggregate limits, or lifetime contribution limits, and no annual contribution limits. Depending on the state you live in, the maximum aggregate limit for your 529 plan will fall between $235,000 and $550,000.

These high contribution limits can help you maximize the available 529 plan tax benefits.

4. You Can Use 529 Plan Contributions to Reduce Your Taxable Estate

You may be able to contribute as much as you’d like to a 529 plan each year, but after a certain threshold, the IRS will take notice.

As of 2023, donors can contribute up to $17,000 per year per beneficiary to a 529 plan, but anything more will count against their lifetime gift exemption. They’ll also have to report the gift to the IRS on Form 709. (It’s important to note that the lifetime gift exemption is $12.92 million in 2023, so not too many people have to worry about hitting it.)

There is a way around this limit, however. Donors can front-load contributions for up to five years at once. So you can contribute $85,000 in one year as long as you don’t make any additional contributions for that beneficiary for five years.

This type of accelerated gifting is unique to 529 plans and can reduce the size of your taxable estate.

5. You Stay in Control of Your Account

With few exceptions, the beneficiary has no legal rights to the funds in a 529 account — the account owner ultimately controls the money. This differs from custodial accounts under UGMA/UTMA, where the child takes control of the assets once he or she reaches legal age.

A 529 account owner can withdraw funds at any time for any reason, but the earnings portion of non-qualified withdrawals will incur federal income tax and an additional 10% penalty tax.

6. 529 Plans are Low Maintenance

Contributions are also often “set it and forget it.” Many plans allow you to automate contributions via payroll deduction or bank account auto-draft. A third-party company will typically handle ongoing investment management, though the account owner may be able to make some decisions.

Contact a financial advisor for guidance.

7. 529 Plans are Highly Flexible

You can change your 529 plan investment options twice per calendar year, and you can roll your funds over into another 529 plan once in a 12-month period. However, there is no federal limit on the frequency of these changes if you replace the account beneficiary with another qualifying family member at the same time.

8. Everyone is Eligible to Take Advantage of a 529 Plan

Unlike Roth IRAs and Coverdell Education Savings Accounts, 529 plans have no income limits, age limits or annual contribution limits. Whatever your financial situation is, you can benefit from a 529 plan’s tax advantages. Most plans have a low minimum contribution or no minimum.

You can also start saving as early as possible. You can open a 529 plan in your own name as an adult, so you can start saving even before a child is born and change the beneficiary later (or even use 529 plan funds for your own education expenses). This flexibility can be helpful if your child receives enough financial aid not to need all the money in their 529 account.

9. Anyone Can Contribute to a Child’s 529 Plan

While parents are the most likely to contribute to a child’s 529 plan, other family members can legally contribute to the plan, too. That includes close relatives such as grandparents, aunts and uncles as well as those less closely related. In fact, anyone can contribute to a 529 plan and name the child as a beneficiary, either through your own plan or that owned by someone else.

10. You Can Roll 529 Funds Over to a Roth IRA

The Secure 2.0 Act of 2022 made it possible to roll 529 funds over to a Roth IRA without incurring penalties or taxes. The lifetime rollover limit is $35,000, but the contributions are subject to annual IRA limits ($6,500 for most, $7,500 for those over age 50). The 529 must also have been open for more than 15 years.

Have questions about 529 plans?

A USSFCU advisor can help. Call 571.205.1515 or schedule an appointment to get started.

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. As always, when dealing with taxes, consult with a professional CPA or advisor. Sources: Savingforcollege.com | Collegesavings.org | Bankrate.com