What is a 529?
A 529 plan is an investment account that offers tax benefits when used to pay for qualified education expenses for a designated beneficiary. You can use a 529 plan to pay for college, K-12 tuition, apprenticeship programs and student loan repayments. If using a 529 plan to save for college, your savings will have a minimal impact on financial aid eligibility.
529 Plan Tax Benefits?
A 529 savings plan works much like a Roth 401(k) or Roth IRA by investing your after-tax contributions in mutual funds, ETFs and other similar investments. Your investment grows on a tax-deferred basis and can be withdrawn tax-free if the money is used to pay for qualified higher education expenses. Contributions are not deductible from federal income taxes.
How to Choose a 529?
Nearly every state has at least one 529 plan available, but you’re not limited to using your home state’s plan. Each 529 plan offers investment portfolios tailored to the account owner’s risk tolerance and time horizon. Your account may go up or down in value based on the performance of the investment option you select. It’s important to consider your investment objectives and compare your options before you invest.
How Much Can I Contribute?
There are no annual 529 plan contribution limits, however, there are some important things to consider when making a large contribution. For example, contributions in excess of the annual gift tax exclusion ($15,000 in 2021) will count against your lifetime estate and gift tax exemption ($11.7 million in 2021).
Each state also has an aggregate contribution limit for 529 plans, which ranges from $235,000 to $529,000. This amount is based on the price of attending an expensive college and graduate school program, including textbooks and room and board.
How does a 529 Plan Affect Financial Aid?
When a dependent student or one of their parents owns a 529 plan account, there is a minimal impact on the student’s financial aid eligibility compared to other savings accounts, such as an UGMA/UTMA account. Assets held in the 529 plan receive favorable treatment on the Free Application for Federal Student Aid (FAFSA), and distributions are not reported.
However, there may be a greater impact on aid eligibility when a grandparent or other third-party owns the account. In this case, assets are not reported, but distributions used to pay for college are considered cash support to the student. This can reduce the student’s eligibility for need-based aid by as much as 50% of the amount of the distribution.
Parent and sibling owned 529 plans
A parent’s reportable 529 plan assets on the FAFSA includes the value of all of the 529 plans they own, including those of their children. 529 plans owned by a parent, including a sibling’s 529 plan, are considered parent assets on the FAFSA.
529 plans owned by anybody else, including a sibling, grandparent, aunt or uncle, are not reported as assets on the student’s FAFSA.
A maximum of 5.64% of parent assets are counted when determining a student’s Expected Family Contribution (EFC). EFC is the amount of money colleges expect a student to be able to pay for college out of pocket, based on their particular financial circumstances.
For example, if a parent has $10,000 in reportable 529 plan assets the college would assume the family had $564 to pay for college, and so the student’s need-based financial aid package would be reduced by $564.
529 plans owned by a grandparent or other third party
A sibling’s 529 plan that is owned by a grandparent or anyone other than a parent does not have to be reported on the FAFSA. Grandparent-owned 529 plans are also not reported on the beneficiary’s FAFSA, however, distributions from a grandparent-owned 529 plan reduce the beneficiary’s need-based financial aid eligibility by as much as 50% of the amount of the distribution.
To avoid hurting a grandchild’s financial aid eligibility, grandparents may change the 529 plan account owner to a parent, rollover a year’s worth of funds to a parent-owned 529 plan after the FAFSA is filed, wait until the student’s last FAFSA is filed to take a distribution or wait until the student graduates and take a non-qualified 529 plan distribution to help pay down student loans. Depending on the timing, these workarounds may affect the sibling’s FAFSA as well.
What are Qualified Education Expenses?
Remember, only qualified withdrawals are tax-free. That means you should only use your 529 plan to pay for qualified educational expenses.
Qualified expenses for college include tuition and fees, books and materials, room and board (for students enrolled at least half-time), computers and related equipment, internet access and special needs equipment for students attending a college, university or other eligible post-secondary educational institutions.
However, there are some costs that you may believe are necessary, but the IRS does not consider a qualified expense. For example, a student’s health insurance and transportation costs are not qualified expenses, unless the college charges them as part of a comprehensive tuition fee or the fee is identified as a fee that is “required for enrollment or attendance” at the college.
In recent years, the IRS has expanded the definition of qualified education expenses to include K-12 tuition expenses and student loan repayments. There is a $10,000 annual limit on qualified K-12 withdrawals and a $10,000 lifetime limit on student loan repayments
The funds in a 529 plan are yours, and you can always withdraw them for any purpose. However, the earnings portion of a non-qualified distribution will be subject to ordinary income taxes and a 10% tax penalty, though there are exceptions.
What happens to money not used in a 529 plan?
If you have leftover money in your 529 plan and you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:
- Change the beneficiary to another qualifying family member
- Hold the funds in the account in case the beneficiary wants to attend grad school later
- Make yourself the beneficiary and further your own education
- Roll over the funds to a 529 ABLE account, a savings account specifically for people living with disabilities
- Since January 1, 2018, parents also have the option to take up to $10,000 in tax-free 529 withdrawals for K-12 tuition
- Since January 1, 2019, qualified distributions from a 529 plan can repay up to $10,000 in student loans per borrower for both the beneficiary and the beneficiary’s siblings
Top Three 529 Plans endorsed by Index Gurus
| Plan Name | New York’s 529 | Edvest | ScholarShare 529 |
| State Affiliation | New York | Wisconsin | California |
| Direct Access | Yes | Yes | Yes |
| Available to residents out of state | Yes | Yes | Yes |
| Expense ratio | 0.13% | 0.07% – 0.35% | 0.08% – 0.57% |
| Tax deduction/credit | For residents | For residents | None |
| Minimum Contribution | None | $25 | None |
| Investments | Both passive and active | Both passive and active | Both passive and active |
| Program match on contributions | None | None | Yes |