Paying for part or all of a child’s college education is a goal many parents and grandparents share. While far from perfect, 529 plans are one of the better college savings options. Anyone planning to contribute to a child’s college education should give them a look.
It’s not just college savers who should bone up on 529 plans, as they can be used to help cover the costs of qualified private school tuition from kindergarten through 12th grade. (More on this later.)
If you are already saving through a 529 plan, well, the rules are subject to change. Plus, you may wonder whether you’ve invested the dollars you’ve already contributed properly.
Because I like to use my own finances as an example, as I recently did in discussing how I manage my cash and my long-term investment portfolio, let me disclose that, yes, I’ve set up a 529 plan for my son and gifted money to my niece’s 529 plan. So, I’m a fan.
However, 529 plans are more complicated than they appear on the surface. Let’s dig in.
I’m going to discuss 529s in three parts. Today, I’ll cover the basics of 529 plans. In part two, I’ll analyze the investment options within The Vanguard 529 Plan. Finally, in part three, I’ll discuss how to invest your college savings.
That said, let me issue a disclaimer. I’m a Vanguard expert, not a 529 pro. I want you to be informed and educated, but none of this is meant to be tax advice or individual financial planning advice.
The rules and regulations around 529 plans change from time to time and vary from state to state. So, I’ll point out where you may need to tread carefully. SavingForCollege is my go-to resource for all things 529-related. When in doubt, look here, check your plan documents or contact the plan directly.
With that out of the way, here’s what you should know about 529 plans.
Key Points
- The money you contribute to a 529 plan grows tax-deferred, and if you spend it on qualified expenses—tuition, room and board, books, a computer, internet access—you can withdraw it tax-free.
- You can contribute up to $18,000 (or $36,000 as a couple) per beneficiary in 2024 without running afoul of gift tax limits.
- Or you can super-fund a 529 plan, giving five years’ worth of gifts today.
- The federal government and your state don’t always agree on what counts as a qualified withdrawal.
- Grandparent-owned 529 plans got a leg up from the simplified FAFSA.
The Basics
If you have a child or grandchild who may one day be college-bound, 529 plans allow you to invest hundreds of thousands of dollars towards a chosen beneficiary’s college education, tax-free. In doing so, you may also better prepare your estate for when you pass away.
There are two basic types of 529 plans to choose from: Prepaid Tuition Plans and College Savings Plans.
Through Prepaid Tuition Plans (PTP), college savers buy credits at participating schools to lock in tuition prices. With a PTP, you are not investing in mutual funds—instead, you are paying today’s tuition price, essentially making a bet on the ever-rising cost of attending college. If you buy shares or credits for a year’s tuition, those credits will always be worth a year’s tuition.
Prepaid plans can be a good fit for some, but they have more strings attached than savings plans and offer less opportunity to grow your investment beyond the cost of college tuition.
College Savings Plans (CSP), on the other hand, function more like Roth IRAs. You contribute after-tax money, but capital gains and income earned in the CSP 529 are not taxed—meaning your assets grow tax-deferred. Qualified withdrawals are also tax-free. Where a Roth IRA is designed for retirement, a CSP 529 plan is geared to cover education costs.
Your CSP 529 plan will be invested in mutual funds, so your return depends on the performance of your holdings. You’ll pick from a selection of stock, bond and money market funds, and many plans feature pre-allocated, diversified portfolios among the investment options. (I’ll dig into Vanguard’s 529 plan investment options next week.)
Contributing
529 plans are flexible when it comes to making contributions—no surprise, they are happy to take your money!
Nearly anyone over 18 can open and contribute to a 529 plan. And the beneficiary of a 529 plan can be virtually anyone, regardless of age—they just need a social security number or tax ID. You can even make yourself the beneficiary. While each plan can only have one beneficiary at a time, changing the beneficiary at any point is possible.
Don’t worry; you, as the contributor, not the beneficiary, remain in control of the plan. (The beneficiary doesn’t have to know you’ve opened it for them.) You determine where to invest the money and when distributions are made from the account.
If you so desire, you can cancel the plan and get your money back—although canceling will incur taxes and some penalties, so don’t make this decision lightly.
How much can you contribute?
Technically, every state limits how much you can contribute to a 529 plan for a beneficiary. However, the limits range from $235,000 to over $550,000, so they aren’t an issue for most savers. If you wanted, you could push, say, a quarter of a million dollars into a 529 plan in one shot. In practice, though, you wouldn’t want to do this.
Contributions over the annual gift tax exclusion—$17,000 in 2023 and $18,000 in 2024—count against your lifetime estate and gift tax exemption. So, practically speaking, most people look at that $18,000 as their “limit” for 2024.