Last updated: 2/20/2023
Do you have children or grandchildren that plan to attend college? Would you like to help them pay for their education in a tax efficient way? Then consider investing in a 529 Education Savings Plan.
What is a 529 Education Savings Plan? In 1996, Congress created these types of tax-advantaged accounts under Section 529 of the Internal Revenue Code. These plans, typically called 529 Education Savings Plans or College 529 Plans, are designed to help families pay for future expenses associated with college or other qualified post-secondary training. And beginning in 2018, some money can be used to pay for tuition for k-12 education.
What are the tax benefits? The tax benefits are very similar to a Roth IRA. Any earnings/growth in your 529 Education Savings Plan are not subject to federal tax, and generally not subject to state tax, when used for qualified education expenses. Just like with a Roth IRA, 529 Education Savings Plan contributions are not deductible. But the potential for tax-free growth is the main tax benefit. Unless you'd rather pay taxes on your education savings growth, then tax-free growth is a good thing.
What is considered a qualified education expense? Look at it this way, if the expense is required for education, then it is generally considered a qualified expense. Tuition, fees, and required books are considered qualified expenses. Room and board is typically qualified, but the student must be enrolled at least half-time and any off-campus housing expenses must not exceed the room and board allowance, as determined by the college or university. In 2009, computer technology (laptops, etc), related equipment, and software were added to the list of qualified expenses, assuming the predominant need is for education. Beginning in 2018, 529 Education Savings Plans can also be used to pay up to a total of $10,000 of tuition per beneficiary each year at an elementary school or secondary (k-12) public, private, or religious school of the beneficiary's choosing. For all expenses, keep good records (receipts, etc) in case you get audited and need to prove anything.
What if the beneficiary doesn't end up needing the funds? 529 Education Savings Plans are very flexible. If the beneficiary doesn't need the funds, you can easily change the beneficiary to another member of the family...siblings, grandchildren, nieces, nephews, etc. Still don't need it for educational expenses? Then any earnings/growth will be added to your taxable income plus a 10% penalty tax. If the beneficiary receives a scholarship, you can avoid the 10% penalty tax, but the growth/earnings will still be added to your taxable income.
How much can you contribute? 529 Education Savings Plans have high contribution limits based on the annual gift exclusion, which is $17,000 in 2023. And with 529 Education Savings Plans you can make a lump sum contribution up to $85,000 per person if you treat the contribution as being made in equal payments over a 5 year period. To avoid a gift tax, just make sure you don't make any additional gifts to the beneficiary over the next 5 years.
Does it matter where you live? Yes. There are several 529 Education Savings Plans to choose from, and each is sponsored by a state or educational institution. All 50 states sponsor at least one type of 529 Education Savings Plan. For example, the state of Kansas sponsors the Charles Schwab 529 Education Savings Plan. I know, very confusing. Depending on where you live, your in-state 529 Education Savings Plan may offer benefits that are not available if you use an out-of-state 529 Education Savings Plan. Generally speaking, if you live in a state with a state income tax, there is usually a benefit to using your in-state 529 Education Savings Plan. Here's a tip to find the possible benefits of your in-state 529 Education Savings Plan, just Google it...('insert your state' 529 plan). By the way, no matter what 529 Education Savings Plan you choose, the investments in your 529 Education Savings Plan can be used at any accredited college or university in the country.
How much will college cost...and how much do you need to be saving? American Funds has a great calculator that will help you estimate both. You can even select a specific college if you have one in mind. Here's the link: American Funds College Savings Calculator (Click here)
529 Education Savings Plan or Roth IRA: If you are trying to decide between investing in a 529 Education Savings Plan or a Roth IRA, I generally recommend people max out their Roth IRA (if eligible) before they contribute to a 529 Education Savings Plan. Why? Because you can always withdraw the contribution portion (basis) of your Roth IRA at any time, for any reason, and without taxes or penalties…only the earnings/growth portion would be subject to taxes and penalties. So you could access your Roth IRA contributions (basis) for education expenses if you need to. FYI, when withdrawing money from your Roth IRA, contributions (basis) come out first, then any earnings/growth. If you do withdraw any earnings/growth from your Roth IRA, you can avoid the 10% penalty tax as long as the money is used for qualified education expenses...however, the earnings/growth portion would still be subject to regular taxes in this case. For these reasons, I generally recommend people max out their Roth IRA (if eligible) before they contribute to a 529 Education Savings Plan. This way, if you don’t need the money for educational purposes, the money in your Roth IRA can be used for your retirement. If you are maxing out your Roth IRA, then go ahead and invest in a 529 Education Savings Plan, which I encourage…because then you will have less need to withdraw money from your retirement funds (Roth IRA) for educational purposes. (Note: With any money you move/convert from a Traditional IRA to a Roth IRA, you have to wait 5 years before you can withdraw that money without incurring a penalty.)
Have more questions? Here's an IRS link: 529 Plan Questions and Answers IRS Link (Click here)
HyLine Bottom Line: A 529 Education Savings Plan may allow you to fund your child(s) or grandchild’(s) education with increased tax efficiency...tax-free growth if used properly.
What can I do at HyLine Wealth to help you with Education Funding? For South Dakota residents (no state income tax), I will help you establish a 529 Education Savings Plan using the Charles Schwab 529 Education Savings Plan. For non-South Dakota residents, I will help you determine if your in-state 529 Education Savings Plan offers benefits that make it a better option or if the Charles Schwab 529 Education Savings Plan is a good fit for you too. And I will focus on keeping your costs low. With the low-cost index portfolios I use, along with my advisory fee, your total all-in cost would be 0.80% per year (less than 1%) with the Charles Schwab 529 Education Savings Plan. That's far less than it would cost you with most other full service advisors. And I will consult with your tax advisor when necessary to confirm any information. Bottom line, I will make this very easy for you.
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Questions? Don’t hesitate to reach out. If you have questions on anything, feel free to email me at firstname.lastname@example.org or call me at (605) 275-2343.
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221 S Phillips Ave, Suite 207
Sioux Falls, SD 57104
Office (605) 275-2343
Location-Independent: Pretty much wherever you are located, we can work together. I am registered in the state of South Dakota and have an office in Sioux Falls. The “de minimis exemption” allows me to do business in most other states (with only a few exceptions). I consider myself "location-independent" as I use a heavy dose of technology to communicate and serve you. This includes screen sharing technology, electronic signatures when possible, and shared client portals so we can view the same information at the same time. Frankly, I can probably offer you better service than your "local" financial advisor.
HyLine Wealth is an investment advisor firm registered in the State of South Dakota. We do not provide tax or legal advice. Past performance is no guarantee of future results. Always consult your financial advisor, tax advisor, attorney, and/or insurance agent before implementing any specific strategy to make sure it is right for you and your unique situation. We are not responsible for the accuracy or upkeep of information on the links we provide to outside websites. If/when we provide a link to an outside website, be sure to independently confirm the accuracy of any information.