Using a 529 Plan for Education Expenses

As many families are gearing back up to start another school year, let's take some time to discuss one of the best savings vehicles for education costs, the 529 College Savings Plan. This investment account has been in existence in one shape or another for a little more than 25 years. The 529 plans were originally established at the state, and not the federal, level to help families save for rapidly rising higher education costs. In the early days of these college savings accounts, thanks to a bipartisan effort led by Senators Bob Graham and Mitch McConnell, Section 529 of the Internal Revenue Code was created, granting federal tax benefits to the plans, and their beneficiaries. Today, all 50 states and Washington D.C. have at least one state-sponsored 529 plan, and the plans seem to be growing in popularity as they continue to evolve to meet the everchanging education landscape. ISS Market Intelligence estimates there are nearly 16 million accounts opened up nationwide with a staggering $458 billion in investment assets.

These 529 plans have undergone several evolutions since their creation, often increasing their flexibility. Until recently these plans were designed and meant to be used for postsecondary education expenses. However, the 2017 Tax Cuts and Jobs Act expanded the usage of these plans to cover the costs of K-12 education. Parents can now use up to $10,000 per year from a 529 plan to pay towards K-12 tuition, and those withdrawals are tax-free. Even more recently, the 2019 Setting Every Community Up for Retirement Enhancement (SECURE) Act created a provision to allow 529 withdrawals to pay off student loan debt, up to a lifetime amount $10,000 per individual.

Most states will grant tax deductions to taxpayers for their contributions to a 529 plan (subject to state tax deduction limitations, which vary by state). Some states, including Missouri and Kansas, will even allow taxpayers to take a deduction for contributions to another state's 529 plan. For example, a Kansas taxpayer can receive a tax deduction for a contribution made to the Nevada-sponsored 529 plan, and they can withdrawal those funds tax-free to pay for qualified expenses when they send their child to Missouri State University in Springfield, Missouri.

While these plans don't have annual contribution limits like many other tax-advantaged investment accounts, such as a Roth IRA, the contributions made to them are considered to be gifts for federal income tax purposes. 529 plans will also have caps on the amount of money that can be saved to them. For example, the Kansas Learning Quest Advisor plan will accepts contributions until all account balances in Kansas' 529 plans for the same beneficiary reach $450,000.

When choosing which 529 plan to use for your education savings goals, make sure to consider the investment options and underlying expenses in each plan. The website Saving For College has a great comparison tool. Some plans will only allow in-state residents to use their state-sponsored plans, while others are open to non-residents.

It's also important to consider how the funds will be used in the future. With higher education costs coming under increasing public scrutiny, we may see changes to the landscape of postsecondary education, and with those changes, we're likely to continue to see 529 plans evolve. For aggressive savers, or for contributors with beneficiaries who find other ways of paying for their education costs (via scholarships or grants), the question may be how to get their money back out of the plans when there is no further need for savings dedicated to fund education. While 529 plans can have beneficiaries changed, sometimes cashing out the plan is decided as the course of action. When 529 proceeds are withdrawn and not used for qualified expenses, there is generally a 10% penalty as well as income tax assessed on the gains of the contributions made to the plan.