How Does A 529 Plan Work?

The fA 529 plan is a type of savings account that is meant to save money specifically towards college. The biggest benefit of this plan is that it offers tax breaks if the money is used for qualified expenses. But how does a 529 savings plan work?

A family discussing 529 saving plans

What is a 529 Plan?

Every 529 plan account has an account owner and a beneficiary. In most cases parents open 529 savings accounts for each of their kids. The aim is to save money for college education. When the money from a 529 plan is used for qualified expenses, it does not attract any taxes. Qualified expenses include all expenses related to tuition, fees, books, room, board, and other education-related supplies.

Earlier this was only applicable for college expenses. Very recently it was amended to also include K – 12 tuition with a few restrictions. The amount that can be withdrawn per year tax-free for qualified K-12 expenses is limited to $10,000.

What Happens If the Beneficiary Doesn’t Go To College?

It happens. Your appointed beneficiary may have made career plans that don’t involve going to college. If your child decides not to go to college, you can name your next child as the beneficiary without a tax penalty. This ensures that your entire fund remains intact and you don’t lose your savings towards taxes.

If the beneficiary is your only child, you can appoint somebody else who is not a family member. The only requirements are that this person must be an U.S. citizen with a Social Security number.  You won’t pay any taxes if you use the money for the beneficiary’s education expenses.

What Happens If You Use The Money For Non-Qualified Expenses?

Maybe your children have no plans to attend college and you don’t know anybody else. You can use the money for some other purpose or even toward your retirement savings. However, if the money is not used for college, you will have to pay a 10% penalty fee and back income taxes on any money that you withdraw. This is to dissuade people from taking advantage of the 520 plan to evade taxes.

Advantages of 529 College Savings Plans

Tax-free growth and withdrawals are the biggest advantages of 529 plans. Any money you invest grows tax-free. You can also withdraw it tax-free if used for education expenses

In addition, many states offer state income tax deductions on 529 plan contributions. This means higher savings.

529 plans have no income restrictions. You can save as much or as little as you want depending on your financial circumstances.

It’s easy to change beneficiaries in a 529 savings account plan. If your appointed beneficiary doesn’t need the money, you can simply use the funds for another student’s expenses.

Disadvantages of 529 College Savings Plans

The biggest disadvantage is that you only enjoy the tax protection if you use the funds for qualified education expenses. If the funds are used for other purposes, it is taxed and also subject to a 10% penalty.

Different 529 Plan Options

Every state in the US, including DC, has some form of a plan. Of course, rules vary by state. In some states, parents can start investing in a 529 before their child is even born. The best 529 plans boast large returns. Many plans also go one step further by locking in tuition savings. Most of the plans don’t require you to be a resident of the state whose plan you choose to invest in.

How Does A 529 Plan Work?

Now that you know how a 529 plan works, is it right for you? These plans are very popular for a reason, but they still require some forethought and planning. Want additional information? Check out SEC.gov for more!

Even with proper planning, many families must turn to taking out student loans to help cover college costs. If that’s the case, you’ll need to find a student loan that fits your needs. Check out our free Student Loan Finder to compare lenders and rates side by side.

 

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