If college or future educational savings are a financial goal, you can find ways to put funds aside and snag some potential tax savings benefits, too
You may know that 529 plans, a type of education savings account, can be used to help pay for expenses for kids who go to a college or university. But did you also know that 529 savings can go toward community college and trade school, too?
About one-third of families put money aside in a 529—but over half aren’t aware that 529s even exist.
Traditional 529 plans are the most common and most flexible. Pre-paid 529 tuition plans, on the other hand, have limitations.
| 529 type | Can be used for |
|---|---|
| 529 college savings plans | Qualified education expenses such as tuition, room and board, mandatory fees, textbooks, computers and related equipment, supplies, special needs, room and board for half-time students, and up to $10,000 in tuition expenses at private, public, and religious K-12 schools (state dependent). You designate how and where to spend the money. |
| 529 pre-paid tuition plans | Prepaid tuition and fees (in lump sums or installments) at today’s rates at eligible public and private colleges and universities. These are state specific, so read the fine print. While you lock in prices and can cover up to five years of tuition, you may or may not be able to transfer the funds elsewhere or to a different beneficiary, or use them for books or supplies. |
No matter the type, the person who sets up the 529—the account owner—typically controls it until the funds are withdrawn. Important to note: Additional donors, such as grandparents or any adult, can also set up 529s.
The beneficiary of a 529 plan can be changed to another child or grandchild, or even for yourself if you go back to school. That’s helpful if one child decides to work right out of high school, for example, and another wants further education.
There is no federal tax deduction for contributions to 529 plans, but some states have options for reporting those funds. And that’s not the only tax benefit. However, before you save in a 529 plan, consider how it may fit into future financial aid.
| Deducting your 529 plan contributions | Contributions are made with after-tax dollars. Nearly 40 states offer a full or partial tax deduction or credit for 529 plan contributions. Visit SavingforCollege.com to see if your state qualifies. |
|---|---|
| Other tax benefits to 529 plans | Earnings grow on a tax-deferred basis, and you don’t pay federal taxes on 529 plan withdrawals when the money is used for qualified educational expenses. |
| Using 529 plans’ | Depending on your state, you can withdraw up to $10,000 (lifetime cap per borrower) from 529 plans to pay principal and interest on a qualified student loan for a 529 beneficiary. Visit your state’s 529 site to find out how your state handles withdrawals for student loan repayment. |
| Effect of 529 plans on financial aid | Who owns the account determines whether it impacts financial aid. For example, if a parent is the account owner, a student’s financial aid award could be reduced by as much as 5.64%
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The tax implications also impact estate plans and capital gains, too. “A 529 savings plan may help minimize potential taxes because earnings aren’t treated as ordinary income and there aren’t capital gains taxes assessed,” says Heather Winston, product director at Principal®. “There are also ways estate taxes can be minimized, too, because any money contributed to the 529 is considered outside of the owner’s taxable estate.”
It’s important to note that 529 plans are not run by the federal government; each state implements its own 529 plans and rules. Sometimes, however, you may be able to contribute to a 529 plan in another state; a tax advisor or financial professional can help you sort through the options. A few important notes:
- Contribution limits: States set maximum contributions limits over the life of a 529—the highest (New Hampshire) topping $621,000.
- State tax advantages: These vary and may depend on your state residency.
- Investment options: Much like you have options with a 401(k), you’ll have options (sometimes age based) for how you invest 529 funds.
- Fees and expenses: As with any investment, you’ll likely have these, but they can also vary widely even in plans within the same state.
Starting in 2024, a provision of the federal SECURE 2.0 Act, allows excess funds to be rolled over into a Roth IRA tax-free. The Roth IRA must belong to the beneficiary of the 529, there’s a lifetime transfer limit of $35,000, and the 529 must have been open for at least 15 years. Other factors also apply; consult a financial professional for details.
If saving in a 529 plan is a goal you have, start by seeing what your state offers. You may find that tax breaks or fees benefit in-state residents. If you’re able to, saving early may benefit your child or grandchild; those savings will have more time to potentially grow. And, as with other savings goals, what you put away may vary from year to year based on other financial goals and needs.
What’s next?
You can save for both college and retirement, and it’s good to check on your progress on both regularly. Not sure how much you’re saving? Log in to principal.com to check your savings rate. Don’t have an employer-sponsored retirement account or want to save even more? We can help you set up your retirement savings with an individual retirement account (IRA).
