529 plan– named on the section 529 of the Internal Revenue Code is a savings plan offering tax and financial aid benefits. This plan encourages saving for the future education expenditure and costs. Legally known as the ‘Qualifying tuition plans’ this plan is generally sponsored by the state agencies or any educational institutions. These savings can also be used for k-12 expenses in addition to the college expenses.
How Does The 529 Plan Work?
A 529 plan is a special savings account which helps in saving for future educational costs as well as being tax advantageous at the same time. Each account has an account owner and a beneficiary. The account owner controls the investments and also chooses the beneficiary. The account owner and the beneficiary can also be the same person.
529 are easy to handle and much easier to save. Starting from as low as $15 or $25 a month, automatic investments can be scheduled directly from bank accounts or pay checks.
There are two types of 529 plans:
- Prepaid tuition plans
- Education savings plans.
Prepaid Tuition Plans:
In the prepaid tuition plans, the account owner can purchase credits from participating universities/ colleges (mostly public and in-state) for future education expenditure at the current prices. This means that no matter how much the price increases over time, the beneficiary will be ready for it. These plans do not allow future residence (room and board) and also do not allow paying for the elementary and secondary tuition’s.
Mostly the federal government doesn’t guarantee these plans. Sometimes a few plans guarantee the money you put into them but a few do not.
If your prepaid tuition plan is not guaranteed, you can lose your money either partly or completely depending on the financial shortcomings or downfall of the sponsor for the plan you had chosen.
Also, whether the beneficiary is attending the participating university/ college plays a major role in the pay that this plan gives. The attending beneficiary will receive more than the non- attending beneficiary.
For the latter, the sponsor will only pay a small return/ pay on the original investments.
Education Savings Plans:
Education savings plans let the investor/ saver open an account to save for any or all of the future education expenditure or costs which includes all of the costs like residence (room and boarding’s), tuition fees, mandatory fees etc.
The money withdrawn from this type of plan can be used at almost any educational costs including boarding/Residence costs. This Education saving plan enables the account owner to pay $10000 per year per beneficiary for the educational costs at any educational institutions (private, public or religious elementary or secondary institutes/ schools)
Depending on when you plan to withdraw your money, the risk profile of the portfolio must be decided and only then investments are to be made. For example, if you plan on using this plan to pay for secondary and elementary schools, you will have a shorter time period to grow. Also, when you plan to withdraw your investments soon, you would not want to invest in a risky or volatile portfolio. Research is needed to estimate the dynamics of the portfolio before you start investing and then invest as how much you withdraw and when you withdraw play a major role on how well this type of the 529 plan will work for you.
Benefits And Contributions of The 529 Plan:
Investing the 529 plan is a great idea because not only it helps save for future education, but it also offers tax benefits.
The earnings from the 529 plan you get through your investments are non- taxable. These keep on growing as per your investments all the time being federal tax- free.
Not only the earning you get being tax- free, you will also get tax breaks. Many states give a full or partial tax deduction or credits/ compensations for the contributions from the 529 plan investments and earnings.
The 529 plans are very easy to use, and the owner stays in charge of where the money goes instead of the beneficiary assuring that the investments will be used for the owners intended purposes.
These do not have to be reported on to your income tax returns and the 1099 form is not required to be filed until the year you start making withdrawals.
The best part about these plans is that there is no income or age limit to be eligible for the 529 plan.
Withdrawals:
As defined, the 529 plans are meant to be used for educational purposes and the earnings that grow over time aren’t subject to the federal tax. However, if the 529 plan account withdrawals are not used for the educational purpose (qualified higher education expenditure or tuition costs for the elementary or secondary schools) they will be subject to state and federal income taxes and also a 10% additional federal tax penalty on earnings is levied.
One of the major benefits of 529 plans is the tax-free earnings that grow over time. The longer the time period you invest, the more your earnings grow and the greater your taxes get benefited. If you withdraw money from a 529 plan account within a short period of time after its investments and contributions, you will lose some or almost all these potential benefits