A 529 plan is a tax-free savings plan designed to assist with the cost of higher education. Initially restricted to postsecondary education costs, it was expanded in 2017 to include K-12 education and apprenticeship programs in 2019.
Section 529 of the Internal Revenue Code authorizes 529 plans, which are legally known as “qualified tuition plans” and are sponsored by states, state agencies, or educational institutions. A 529 account can be opened by anyone, but they are typically opened by parents or grandparents on behalf of a child or grandchild who will be the account’s beneficiary.
Types of 529 Plans
- Savings plans
- Prepaid tuition plans
The savings plans allow a saver to open an investment account in order to save for a beneficiary’s future qualified higher education expenses, such as tuition, mandatory fees, and room and board while the Prepaid tuition plans allow a saver or account holder to acquire units or credits at participating colleges and universities (typically public and in-state) for the beneficiary’s prospective tuition and mandatory fees at current costs.
Rules of the 529 Plan
- The rules for qualified distribution are very rigid.
- Although 529 plans are state-sponsored, you can choose a plan from any state.
- The account holder takes control of the funds.
Limits of the 529 Plan
According to the IRS, “contributions cannot exceed the amount necessary to provide for the beneficiary’s qualified education expenses.” As a result, unlike other tax-advantaged accounts, such as Roth and traditional IRAs, the IRS does not set specific contribution limits for 529 plans. Most states set limits ranging from $235,000 to $529,000.
Contributions, on the other hand, may result in gift tax consequences if you make more than the gift tax exclusion ($16,000 in 2022) for any one beneficiary in a tax year. The vast majority of people do not need to be concerned about this because they will almost certainly not need to contribute that much per year to meet their savings goals.
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A 529 plan is advantageous for parents who value a college education and wish to save money when making financial contributions. The benefits are too good to pass up: contributions grow tax-free, and withdrawals are tax-free as long as they are used for qualified education expenses.
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