Navigating 529 College Savings Plans: How They Work

September is College Savings Month, tune in weekly as we complete an in-depth review of the intricacies related to 529 College Savings plans. This week we will discuss the basic structure of 529 plans; how they work. 

When a 529 account is opened, the account will have an owner and a beneficiary. The beneficiary is the individual who will reap the benefits of paid education expenses. Many are accustomed to a beneficiary being a child, but few know that you can open the account with an adult beneficiary. This may be an option for someone wanting a head start for a future beneficiary, or to pay for their own education expenses.  

Typically, at least one plan per state is offered. In each plan, there are investment options to choose from, whether that be an age-based fund or a basket of mutual funds. 529 plans are unique in that they only allow two investment changes per year. In turbulent waters, choosing the correct allocation is detrimental. We recommend that you consult with your advisor to help determine which investment path is appropriate for you. 

Some consider 529 plans to be the ‘Roth IRA’ of education savings.  Even though you are funding your account with after-tax dollars, whether that be in a lump sum, periodically, or randomly, the account growth is tax deferred. In this instance, that means that your account will not be taxed until distribution. BUT, as long as the expenses your distribution is going toward are considered qualified, your distribution will ultimately be tax free. 

Lastly, distributions from 529 plans can be made directly to the institution of higher learning or paid to the account owner or beneficiary for reimbursement. As mentioned, if distributions are made for education expenses that fit the description for qualified, they are tax-free, if not, they will be taxed and penalized. 

When used as intended, 529 plans can offer some of the richest benefits the financial industry has to offer. Tax deductible contributions, tax-free growth, and tax-free distributions are powerful tools for building wealth. We’ll cover how recent rule changes make them even more attractive for longer-term planning in future posts.