It’s no secret that the cost of college is rising rapidly. In 2023, the average one-year cost for an in-state college student sits at $25,707. Average fees for out-of-state or private universities are even higher. The creeping college price tag means it’s never been more important to have a plan in place to pay for college.
Still, some parents aren’t sure how to approach accounts designed for college savings. We hear from clients who are concerned that their child won’t want to attend college and that the funds in a college savings account will be wasted.
Fortunately, the government is constantly evolving the rules around 529s plans—the vehicle primarily used for college savings. These funds can be used to pay for a private grade or high school, as well as trade schools. Plus, as of late 2022, beneficiaries can roll excess funds into a Roth IRA if they follow certain rules.
The basics of opening a 529
All 529 plans are opened and operated through the state, with the exception of Wyoming, which uses Colorado’s plan. You are not required to open a 529 plan through the state you’re currently residing in. However, many states offer additional tax benefits for residents who opt to contribute to an in-state plan.
Virginia and Maryland both offer income tax breaks for using their in-state plans, and Virginia’s plan tends to be highly rated nationwide due to its lower-than-average fees.
However, state taxes aren’t the only criteria to consider. A 529 is an investment account and as with any investment account, you should review both its historical performance and ongoing fees.
As you research different 529 funds, keep in mind: Most states have two 529 funds. One is available directly to retail investors, and one is available to investment professionals (including financial advisors, like Bogart Wealth). Make sure your research reflects the type of account you hope to open.
Tax advantages of a 529
A 529 is a tax-advantaged account, meaning the money you contribute grows tax-free. You contribute to a 529 after tax, and if you use the money to pay for qualifying educational expenses, there’s no federal income tax on withdrawals.
At the state level, your state may offer incentives for contributing to your state plan (as noted in the graphic above). Some states (Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania) offer tax incentives for contributing to any 529 plan, not just the in-state option.
Contributing to a 529
Unlike IRAs or 401(k)s, there are no annual contribution limits for 529 plans. That doesn’t mean families can make unlimited contributions, however. Most plans have limits to ensure you aren’t contributing more than you expect the recipient’s education to actually cost. These restrictions vary plan by plan, so you’ll want to research that carefully if you’re looking to contribute a significant amount.
If you have loved ones (grandparents, aunts and uncles, friends) who want to help pay for a child’s future college costs, they are allowed to contribute to the 529 plan as well. All plans allow for third-party contributions. The actual process for third-party contributions will vary by plan, so this is another factor to consider when choosing the right 529 for your family.
Contributions from friends and family in excess of $15,000 (or $30,000 for married couples filing jointly) may trigger a gift tax.
It’s worth noting third parties (like grandparents) may be able to open separate 529s for a student beneficiary. Depending on your financial circumstances, this may be a helpful tool, as money in a 529 owned by a grandparent is not considered as part of the Free Application for Federal Student Aid (FAFSA).
Financial advisors can help you evaluate which options make the most sense in light of your family’s unique circumstances.
Rules around 529s
The government is continually revising the rules around 529s to make them a more useful tool for parents. In 2017, rules were revised to allow parents to use 529 funds to pay for K-12 education within certain parameters. Similarly, while 529s were originally designed to help pay for traditional post-secondary education, they can now be used to pay for various vocational programs. You can also update the beneficiary of a 529 plan if your child decides not to go to college; use the funds for another family member or take a continuing education class yourself.
Congress added more flexibility at the end of 2022. Going forward, the beneficiary of a 529 plan can roll up to $35,000 into a Roth IRA account. There are restrictions, naturally: The 529 must have been opened for 15 years, rollovers are subject to certain balance restrictions, and standard Roth IRA contribution limits apply.
We talk more about the latest changes to 529 plans in our deep dive into the SECURE Act 2.0. Read our full white paper.
