A 529 plan provides the potential for the account owner to grow an education savings by accumulating earnings on a tax-deferred basis. If the funds are used for qualified education expenses they can be withdrawn tax-free.
529 Plans
Starting a 529 plan can be an important tool as you focus on your family’s overall financial future. Setting up a 529 plan for your children can help you create a solid foundation for their education and help you reach one of your financial goals.
What is a 529 plan?
A 529 plan is an education savings plan sponsored by a state and can be used for education expenses. These plans are tax-advantaged and money contributed to them can be invested for example in mutual funds and exchange-traded funds, to allow for potential growth over time. As with any investment, a 529 plan will experience market changes that may affect its worth when it is redeemed.
Compared with other education savings vehicles, a 529 can offer more flexibility and better control for the account owner. For the beneficiary, this plan may be able to offset some or all of what they would have had to take out in student loan debt.
There are no age limits for who is eligible to be a beneficiary of a 529 plan. The account owner sets up the account for one beneficiary. If the named beneficiary decides not to attend the school, the account owner can change the beneficiary to another eligible family member.
In addition to the account owner, anyone is able to contribute to the account. This includes grandparents, family friends, parents and others, regardless of their income. Contribution limits will vary according to each state’s plan.
What to look for in a 529 plan
To get the most benefit from a 529 education savings plan, make sure it includes these aspects:
- Investment principles of quality and diversification
- Asset allocation that aligns with:
- Return objectives
- Risk tolerance
- Time horizon of the education savings goal
- A rebalancing strategy to help ensure asset allocation continues to align with return and risk objectives
As you create a savings strategy for your financial future, building education savings for your children can be included without completely sacrificing other priorities. Young families might hesitate to set aside the money for a 529 plan, but the earlier you can start saving, the more time your investments have the potential to grow.
Lack of awareness and understanding are two reasons why people aren’t utilizing the opportunities of a 529 plan. According to results collected by Edward Jones from a recent survey
There are two types of 529 plans – 529 prepaid tuition plans and 529 education savings plans. Although they both offer ways to save money on future education costs, the structure and intent of these plans are very different. Prepaid tuition plans are limited to use only for tuition expenses, cannot offer potential investment growth and have set guidelines for enrollment based on a student’s age. However, with a prepaid tuition plan the provider or the plan (usually the state or university) bears the risk associated with the plan. Education savings plans, on the other hand, cover more education-related costs, possible account growth through investments and few, if any, enrollment restrictions. However, the account owner and beneficiary bear the investment risk with the education savings plan.
529 prepaid tuition plans
A 529 prepaid tuition plan is a contract that can be purchased based on the current tuition rate of an eligible public or private college or university within a certain state. The amounts of tuition can be paid as a lump sum or installed payments and offer options for two- to four-year undergraduate programs or graduate school. In some cases, the contract can be a combination ranging from one to five years of tuition. A number of states offer a guarantee to keep prepaid plan amounts in pace with tuition costs or promised financial assistance if the program experiences a funding challenge. Since these plans are state sponsored, either the account holder or the beneficiary may need be a resident for plan eligibility. Prepaid tuition plans are primarily designed to offset tuition costs, so any related costs, such as housing, may need to be covered outside of the plan.
529 education savings plans
A 529 education savings plan is a state-sponsored investment account that can be used toward elementary, secondary (in some states) or higher education expenses, including many colleges, universities, trade schools and for apprenticeships, for the account beneficiary. There are fewer restrictions for residency with many states offering 529 savings plans to out-of-state residents. These plans also allow contributions to be used for other costs, in addition to tuition savings.
The biggest benefit of starting a 529 plan is being able to help save on future education costs. With tuition rates continuing to rise, setting aside money, even a small amount, every month can make a big difference. Starting from when your children are born is often a great way to incorporate this goal into your financial strategy, but even if your kids are older you can still make progress by contributing to this goal. Another option for building an education savings account is to invest dollar amounts that were previously earmarked for services your children no longer need or use, such as day care.
The chart below shows how starting early and then incorporating just a portion of a typical daycare bill can grow to be sizable education savings amount over time.
Source: Edward Jones
This graph shows the amount you save each month and when you start saving for a child can make a real difference. The green line shows you'll accumulate $23,000 if you put aside $100 per month for a child from age 5 to age 18. The blue line shows you'll accumulate $38,000 if you put aside $100 per month starting at birth through age 18. The red lines show you'll accumulate $105,000 if you put aside an additional $300 per month from age 5 to age 18. Calculations assume saving $100 a month until the child reaches age 18, with an annual rate of return of 7% until age 10, 6% from ages 10 to 16, and 3% thereafter. Numbers rounded to nearest thousand. This graph is for illustrative purposes only and does not represent any currently available investments.
Contribution limits are set by the state offering the plan, and all 529 plans prohibit contributions once the account balance reaches a certain point, typically more than $235,000. The actual amount can vary depending on the plan.
The federal gift tax exclusion allows a contributor to give up to $17,000 per year per beneficiary, or $34,000 if you're giving as a married couple. The 529 plan account owner may make an election that allows for a contribution up to five times the annual exclusion amount. This allows the gift to be considered prorated over five years. For example, if the annual exclusion amount is $17,000, a married couple with two children (named as beneficiaries on two separate 529 accounts) can contribute $170,000 for each child in one year without it counting toward their overall estate and gift tax exclusion amounts.
Contributions from friends and other relatives
When contributions are made by friends or other family members, these are considered gifts from each person. These gift contribution amounts won’t affect the gifting limits of the parents or the plan’s account owner unless they are also the beneficiary. This offers others who want to contribute the option of giving to an existing 529 plan account they do not own or establishing an account to retain ownership. Gift contributions to 529 plans will count toward the annual gifting limit.
Accelerated giving provisions
Account owners who participate in their home state’s 529 education savings plan may be eligible for a state income tax deduction for contributions made. Seven states provide for state tax parity, allowing contributions to any state plan to be eligible for that state’s income tax deduction.
These states are:
- Pennsylvania
- Arizona
- Missouri,
- Minnesota,
- Montana
- Arkansas
- Kansas
Find your state’s 529 plan
There are different resources available to help you learn more about your home state’s 529 education savings plan and those offered by other states. This is an optimal time to consider how a 529 plan can work with your other savings goals. Your financial advisor can work with you to help you navigate this process.
Keep in mind, as a 529 education savings plan account owner, you may also be eligible for other potential
How 529 plans impact financial aid
A 529 education savings plan is considered a parental asset, whether it is owned by the parent or the child. That means it should have a relatively low impact on a student's financial aid, but it is a good idea to talk with the college’s financial aid office well ahead of the time when your child will start attending school.
It may also be useful to learn what kind of financial aid is available from federal, state, local and private funding. Visit the U.S. Department of Education’s Federal Student Aid site to start your financial aid research. It has all necessary forms, including the Free Application for Federal Student Aid (FAFSA). You can also read about the qualification criteria used for financial aid calculations.
Since the plan’s earnings accumulate tax-free, withdrawals are federally income tax-free and penalty-free, as long as they are used for qualified education expenses. Qualified post-secondary education expenses include:
- Tuition and fees
- Books
- Required school supplies
- Room and board – if the beneficiary is considered at least a half-time student (including off-campus housing – the equivalent of what it costs to live on campus)
- Computers and related accessories, such as printers, internet access and educational software primarily used by the beneficiary
Additional qualified uses
New laws have been put in place that expand the potential qualified uses of 529 plans. Distributions can be used to pay for up to $10,000 a year per beneficiary for elementary and secondary school (public, private and religious) tuition expenses, which are not subject to federal income tax. Plans can also pay for qualified costs associated with apprenticeship programs. Eligible programs can be offered through trade schools and community colleges and must be registered with the U.S. Department of Labor. In addition, 529 plans can help repay certain student loans, up to a $10,000 limit.
Enhanced flexibility for unused 529 assets
A common question that arises when parents think about setting up a 529 account is, "What if my child doesn't end up going to college?" A recently passed piece of legislation known as the Secure 2.0 Act may help provide some enhanced flexibility to those who encounter this situation. Beginning in 2024, 529 account owners can roll over unused 529 assets to a Roth IRA for the beneficiary, subject to certain criteria and limitations.
For important details on the changes, criteria, limitations and what the new legislation could mean for you, please see our Secure Act 2.0 page.
How to get started
Our Edward Jones financial advisors continue to work with clients on their evolving financial priorities, including saving for education.
Trying to understand and plan for future education costs can seem overwhelming and confusing. Your Edward Jones financial advisor can work with you to review your overall financial strategy and determine how to reach all of your family’s saving goals, including education.
Contact your Edward Jones financial advisor or find one today!
Kyle Harpin, CFA®, CFP®
Kyle Harpin is an analyst on the Client Needs Research team, which creates advice and guidance related to preparing for retirement, living in retirement, saving for education, estate planning considerations and protecting financial goals.
Kyle graduated summa cum laude from the W.P. Carey School of Business at Arizona State University with a bachelor’s degree in finance. He is a CFA® charter-holder and a member of the CFA Institute and the CFA Society of Nevada. Kyle also holds the CFP® designation.
Important information:
1If you live in a state that does not recognize the expanded use of 529 plan funds and will be required to adopt additional legislation regarding its 529 plan and state income tax incentives, and you withdraw funds before those states recognize the use of 529 plan funds for elementary or secondary school tuition, you may risk having to repay a state tax deduction you've already received, may face state taxes on the investment gains in the account and/or may incur additional penalties. Tax issues for 529 plans can be complex, so we recommend you consult a qualified tax advisor regarding your situation.
Withdrawals used for expenses other than qualified education expenses may be subject to federal and state taxes, plus a 10% penalty on the earnings portion of the distribution. State tax incentives and additional benefits may be available to in-state residents who invest in their home state’s 529 plans. Student and parental assets and income are considered when applying for financial aid. Generally, a 529 plan is considered an asset of the parent, which may be an advantage, in terms of receiving financial aid, compared to building savings in the student’s name. Make sure you discuss the potential financial aid impacts with a financial aid professional. This content should not be depended upon for other than broadly informational purposes.
Please consult your tax advisor about your situation. Edward Jones, its financial advisors and employees cannot provide tax or legal advice.
Edward Jones receives payments known as revenue sharing from certain mutual fund companies, 529 plan program managers and insurance companies (collectively referred to as “product partners”). For more information, see Revenue Sharing Disclosure.
2 2022 amount.