Clueless about 529 plans? Here’s a guide


Q. I am clueless about 529 plans. My mom wants to open one up for her great-granddaughter who is 15 months old. I understand you can open a plan in another state and not just the state where you live. Does that mean the beneficiary of that plan has to attend college in that state? Also, is it true the 529 plan can be used for grade school education?
— Learning

A. Your mom is smart to be considering a 529 plan account for her great-granddaughter. These plans are among the most generous, flexible, and tax-beneficial options for education savings.

A 529 plan, technically known as a “qualified tuition program” under Section 529 of the Internal Revenue Code, is an education savings plan that provides major tax advantages, said Gene McGovern of McGovern Financial Advisors in Westfield.

He said the plans are generally established by individual states, and they come in two different versions.

One version — the prepaid tuition plan — allows you to purchase college credits now at today’s prices, McGovern said.

“When your child attends school years later, the tuition for those credits is guaranteed to be covered, no matter how much it’s risen in the meantime,” he said. “With college tuition generally rising rapidly, prepaid plans can offer an attractive tax-free return on your investment, although various restrictions, such as attending an in-state school, may apply.”

The other version, the 529 savings plan, is the more popular of the two and the one your mom is considering for her great-granddaughter.

All 50 states and the District of Columbia offer these savings plans, he said.

“Contributions to a 529 plan are not tax-deductible on your federal income tax return, but the earnings on those contributions grow tax-deferred and are tax-free when withdrawn, provided the funds are used for education expenses,” he said.

The catch? If 529 plan earnings are withdrawn and not used for education expenses, they’re subject not only to income tax but also to a 10 percent penalty tax, McGovern said.

There are many advantages to 529 plans. You can use the funds for nearly all higher education expenses, including tuition, room and board, and related expenses such as computers and software, provided the student is enrolled at least half-time, he said.

There are no income limitations on your ability to contribute to a 529 plan, and the amounts that can be contributed are substantial.

New Jersey’s plan, for example, known as the NJBEST 529 College Savings Plan, allows contributions of up to $305,000 per beneficiary over the lifetime of the account, and you can get started with as little as $25, McGovern said.

“Other 529 plan advantages include the ability to change the beneficiary to another family member at any time; a wide range of investment choices; the plan owner stays in control of the money; and many states (but not New Jersey) allow an income tax deduction or credit for 529 plan contributions,” he said.

To your specific questions:

A key feature of 529 plans is that you aren’t restricted to your own state’s plan, McGovern said. You can invest the funds in any state’s plan, and the student can attend college in any state, regardless of the state where the funds are held.

Each state’s 529 plan is unique, so it pays to shop around when choosing a plan, he said, and each has a different combination of sales channels, investment offerings and fees. These include loads, broker-sold plans, enrollment fees, annual maintenance fees and asset management fees.

“Even if your state offers a tax deduction or credit for contributing to your state’s plan, it’s important to weigh that benefit against the performance and costs of other states’ plans,” he said.

You can easily find annual rankings of state 529 plans online or in financial publications.

And, it’s true that 529 plans can now be used for K-12 education, but with more restrictions than apply to college or graduate school expenses.

“Previously, 529 plans could be used to fund only post-secondary education, but Congress changed the rules in the Tax Cuts and Jobs Act of 2017, which now allows up to $10,000 per year per beneficiary to pay for tuition (but not room and board or other expenses) at elementary or secondary schools,” he said. “Not all states have yet conformed their tax rules to the federal rule, but New Jersey has adopted the federal rules in this regard.”

McGovern said you should remember that using 529 plan funds to pay for elementary or secondary education may be helpful in some cases, but at the same time it reduces the benefit of allowing money invested in the plan to compound tax-deferred over a longer period of time.

Finally, make sure your family understands how a 529 plan will impact financial aid so there are no unintended consequences for this account.

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