Save Taxes with 529 Education Plans

In the list of ‘to do’ items after childbirth and child rearing, parents often include the 529 Education plans as well. You want to secure your child’s future by investing in this piggy bank for the education of your children. Megan and Derrick, first time parents, did not want to waste much time, so they invested in 529 Education plan within a month of their child’s birth.

The 529 Education plans have been around since 1996. It is named after Internal Revenue Code (IRC) section 529 and is officially known as a “Qualified Tuition Program”. This is an education vehicle that provides for money to be set aside and/or invested and later used for someone (usually a child) to be able to attend school, and have the education paid for.

The BIG benefit is that the earnings or income is NOT subject to tax, if the money taken from the 529 plan is used for education purposes.

Each state can offer either a Prepaid Tuition Plan or a Savings Plan. Moreover, you do not need to buy a plan in the state you live in. For instance, you can choose to buy a 529 Savings Plan in Utah, while you are living in Arizona.

But beware! If you buy the 529 Prepaid Tuition Plan, you must attend school in that state! Also, you usually don’t earn as much in the 529 Prepaid Tuition Plan, as you do with the 529 Savings Plan.

You can own the 529 plan, but set it up for your children, grand-children or relatives, friends or even yourself. There is an Owner or Custodian and one beneficiary per plan. The beneficiary can be changed without any problem, too. So, if your child, that was designated to benefit from the 529 plan, decides not to go to college, you can designate someone else (anyone). You can even roll money from one 529 plan into a 529 plan of another person without restrictions. There are no limits on who can set up 529 plans, nor is there a limit on how many 529 plans you can own. 

How does it work?

You set up a 529 plan and fund it with money.

How much?

There are certain limits, (be sure to see your tax professional) but let’s say for now, at least $250 and up to $110,000 in one year. Whatever that account earns while it sits there, is tax deferred AND completely tax free when the money is used for eligible education purposes. So, remember, it’s easy to set up a 529 plan, anyone can do it, and make sure you have enough TIME to keep it invested, before you use any of it, for education. As with all investing, the more time you must wait, the more you usually gain from the investments.

The types of Educational Institutions that qualify to be used with 529 plans are:

Any school, public, private, or faith-based (1st grade through 12th grade)

OR

Any college, university, apprenticeship, vocational, trade school, or primary, secondary and post-secondary institution that can participate in a student aid program administered by the Department of Education. 

To get tax free treatment of 529 withdrawals, you must spend the money on Eligible Education Purposes. Examples of this are: tuition, resource fees, books, supplies, registration fees, computers, technology, hardware, software or related equipment, even internet services, room and board. Primary and secondary schools have annual limits on both the amount spent ($10,000 for 2019), while there are no limits placed on expenses paid post-secondary education institutions. For 2020, you can now use 529 withdrawals to repay student loans and interest, up to $10,000 as well.

Another possible benefit for 529 plans is that many states offer tax deductions for contributions made to 529 plan. For example, Arizona offers a $4000 (married couple-2018) deduction, while Colorado offers up to $100,000 (for 2018) as a state tax deduction for that much contributed to a 529 plan!

Be sure to check with Azmoneyguy or another tax professional for current limits.

Look out for “the catch”

As with most tax deferred programs there is a catch. For instance, if you take money out of a 529 plan that is NOT used for education, there is a tax on the earnings amount withdrawn AND a 10% penalty. So be sure to see your tax professional before taking any withdrawals.

Here are some points to remember:

• 529 plans are either Prepaid Tuition plans or Savings plans

• Anyone can set up a 529 plan for anyone, including yourself

• 529 plans are available for primary, secondary, religious, post-secondary, apprenticeship, vocational and trade school educational institutions

• 529 withdrawals can now be used to repay student loans

• The longer you wait to withdraw funds, the more opportunity to grow the plan

• Earnings are tax deferred AND tax free, if used for Eligible Education Purposes

• Eligible Education Purposes include almost everything, but amounts are limited for primary and secondary schools

• Check with your state to see if there are deductions for 529 contributions

• Watch out for tax AND 10% penalty, if non-qualified withdrawals are taken

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