529 Plan: Contribute Today For Your Child’s Tomorrow

It is important to secure your financial future first, before turning to your children’s. However, once you turn to the financial future of your children, a 529 plan should be on the top of the list. 529 plans allows account holders to put away funds for a beneficiary, typically a child or other loved one.

Overview: 529 Plan

529 plans are authorized by Section 529 of the Internal Revenue Code and were designed to encourage saving for future education costs. When first instituted, 529 plans were limited to covering the costs of post-secondary education. Overtime, qualified education costs covered by 529 plans were expanded to also cover K-12 education in 2017 and apprenticeship programs in 2019. In view of the rising costs of education, if you have children, a 529 plan should be apart of your financial tool kit.

Types Of 529 Plans

Generally speaking, there are two types of 529 plans. A prepaid tuition plan or an education savings plan. According to the SEC, most all States and the District of Columbia sponsor at least one of the two types of 529 plans. Additionally, some private colleges and university may also have similar plans. Note that Wyoming is the only State that does not offer its own 529 plan.

Prepaid Plan

The prepaid 529 plan allows account holders to purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and mandatory fees at current prices. As such, you are locking in today’s prices. This can be a significant benefit in view of costs savings when taking into consideration the consistent rise in education costs over time.

Savings Plan

529 savings plan allow an account holder to open an investment account to save for the beneficiary’s future. The saved amount can then be used to pay for qualified expenses. Such qualified expenses include tuition; room and board; mandatory fees; and, books, and computers.

With regard to the investment account, in ways similar to a brokerage account, the account holder can chose from a range of investment options (target date funds, ETFs, Mutual funds) that is offered by the respective State or vender used by the State to carry out the 529 program. As such, prior to selecting a fund to invest in, it is important to carefully review the options available and the associated fees.

Taxes

529 plans are often referred to as a tax advantage account because of the associated federal and State tax advantages.

Contributions

Many States offer tax benefits for contributions to a 529 plan. These tax benefits typically include a State income tax deduction up to a certain limit contributed. Usually, these tax benefits are limited to residents of that State. For example, if you are a resident of Maryland and have a Maryland 529 plan, you would be able to deduct a certain amount of your Maryland 529 contributions from your Maryland State income tax. On the other hand, if you are not a resident of Maryland, and have a Maryland 529 plan, you would not be able to deduct your contribution from your home State’s income tax. 

Unfortunately, unlike the State tax deduction, on a federal level, the money you contribute to a 529 plan is not tax-deductible for federal income tax purposes.

Withdrawal

With regard to withdrawals for qualified expenses, 529 earnings are not subject to federal income tax and, in many cases, State income tax. However, if 529 account withdrawals are not used for qualified expenses, the funds will be subject to both State and federal income taxes and an additional 10% federal tax penalty on earnings.

Growth

Another benefit of 529 plans is the tax-free earnings that grow over a period of time. Growth of funds in your 529 account are not taxed. Therefore, the longer your money is invested in a savings plan, the more time it has to grow and the greater the tax benefit. The upshot here is a simple one. Although contributions are not deductible from your federal income tax, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for qualified expenses. 

Conclusion

It is important to secure your financial future first, before turning to your children. However, once you turn to the financial future of your children, a 529 plan should be on the top of the list. 529 plans allows account holders to put away funds for a beneficiary, typically a child or other loved one. A 529 plan is an easy way to get your child off on the journey to financial independence.

For your convenience, we have provided a chart below with links to the related State 529 plan. Continue on your journey to financial independence.