529 plans can be powerful college savings tools, but you need to understand how your plan works before you can take full advantage of it. Among other things, this means becoming familiar with the finer points of contributions and withdrawals.
How much can you contribute?
To qualify as a 529 plan under federal rules, a state program must not accept contributions
in excess of the anticipated cost of a beneficiary’s qualified education expenses. At one
time, this meant five years of tuition, fees, and room and board at the costliest college
under the plan, pursuant to the federal government’s “safe harbor” guideline. Now,
however, states are interpreting this guideline more broadly, revising their limits to reflect
the cost of attending the most expensive schools in the country and including the cost of
graduate school. As a result, most states have contribution limits of $350,000 and up (and
most states will raise their limits each year to keep up with rising college costs).
A state’s limit will apply to either kind of 529 plan: savings plan or prepaid tuition plan. For
a prepaid tuition plan, the state’s limit is a limit on the total contributions. For example, if
the state’s limit is $400,000, you can’t contribute more than $400,000. On the other hand, a
savings plan limits the value of the account for a beneficiary. When the value of the account
(including contributions and investment earnings) reaches the state’s limit, no more
contributions will be accepted. For example, if the state’s limit is $400,000 and you
contribute $325,000 and the account has $75,000 of earnings, you won’t be able to
contribute any more — the total value of the account has reached the $400,000 limit.
These limits are per beneficiary, so if two people each open an account for the same
beneficiary with the same plan, the combined contributions can’t exceed the plan limit. If
you have accounts in more than one state, ask each plan’s administrator if contributions to
other plans count against the state’s maximum. Generally, contribution limits don’t cross
state lines. In other words, contributions made to one state’s 529 plan don’t count toward
the lifetime contribution limit in another state. But check the rules of each state’s plan.
How little can you start off with?
Some plans have minimum contribution requirements. This could mean one or more of the
following: (1) you have to make a minimum opening deposit when you open your account,
(2) each of your contributions has to be at least a certain amount, or (3) you have to
contribute at least a certain amount every year. But some plans may waive or lower their
minimums (e.g., the opening deposit) if you set up your account for automatic payroll
deductions or bank-account debits. Some will also waive fees if you set up such an
arrangement. (A growing number of companies are letting their employees contribute to savings plans via payroll deduction.) Like contribution limits, minimums vary by plan, so be
sure to ask your plan administrator.
Know your other contribution rules
Here are a few other basic rules that apply to most 529 plans:
- Only cash contributions are accepted (e.g., checks, money orders, credit card
payments). You can’t contribute stocks, bonds, mutual funds, and the like. If you
have money tied up in such assets and would like to invest that money in a 529
plan, you must liquidate the assets first. - Contributions may be made by virtually anyone (e.g., your parents, siblings,
friends). Just because you’re the account owner doesn’t mean you’re the only
one who’s allowed to contribute to the account. - 529 savings plans typically offer several different investment portfolios that you
can pick from to invest your contributions. If you want to change your
investment option, you can generally do so twice per calendar year for your
existing contributions, anytime for your future contributions, or anytime you
change the beneficiary of the account. - 529 account owners who are interested in making K-12 contributions or
withdrawals should understand their state’s rules regarding how K-12 funds will
be treated for tax purposes. Some states may not follow the federal tax
treatment. In addition, account owners should check with the 529 plan
administrator to determine whether a K-12 withdrawal request should be made
payable to the account owner, the beneficiary, or the K-12 institution.
Maximizing your contributions
Although 529 plans are tax-advantaged vehicles, there’s really no way to time your
contributions to minimize federal taxes. (If your state offers a generous income tax
deduction for contributing to its plan, however, consider contributing as much as possible
in your high-income years.) But there may be simple strategies you can use to get the most
out of your contributions.
For example, investing up to your plan’s annual limit every year may help maximize total
contributions. Also, a contribution of $18,000 a year or less in 2024 qualifies for the annual
federal gift tax exclusion. And under special rules unique to 529 plans, you can gift a lump
sum of up to five times the annual gift tax exclusion — $90,000 for individual gifts or
$180,000 for joint gifts — and avoid federal gift tax, provided you make an election on your
tax return to spread the gift evenly over five years. This is a valuable strategy if you wish to
remove assets from your taxable estate.
Lump-sum vs. periodic contributions
A common question is whether to fund a 529 plan gradually over time, or with a lump sum.
The lump sum would seem to be better because 529 plan earnings grow tax deferred — so
the sooner you put money in, the sooner you can start to potentially generate earnings.
Investing a lump sum may also save you fees over the long run. But the lump sum may have
unwanted gift tax consequences, and your opportunities to change your investment
portfolio are limited. Gradual investing may let you easily direct future contributions to
other portfolios in the plan. And realistically, many parents may not be able to fund their
account with a lump sum, but they may be able to easily make monthly investments.
Qualified withdrawals are tax free
Withdrawals from a 529 plan that are used to pay qualified education expenses are
completely free from federal income tax and may also be exempt from state income tax. For
529 savings plans, qualified education expenses include the full cost of tuition, fees, books,
equipment, and room and board (assuming the student is attending at least half-time) at
any college or graduate school in the United States or abroad that is accredited by the
Department of Education; the cost of certified apprenticeship programs (fees, books,
supplies, equipment); student loan repayment (there is a $10,000 lifetime limit per 529
plan beneficiary and $10,000 per each of the beneficiary’s siblings); and K-12 tuition
expenses up to $10,000 per year.
Note: A 529 plan must have a way to make sure that a withdrawal is really used for
qualified education expenses. Many plans require that the college be paid directly for
education expenses; others will prepay or reimburse the beneficiary for such expenses
(receipts or other proof may be required).
Beware of nonqualified withdrawals
A nonqualified withdrawal is any withdrawal that’s not used for qualified education
expenses. For example, if you take money from your account for medical bills or other
necessary expenses, you’re making a nonqualified withdrawal. The earnings portion of any
nonqualified withdrawal is subject to federal income tax and a 10% federal penalty (and
may also be subject to a state penalty and income tax).
Is timing withdrawals important?
As account owner, you can decide when to withdraw funds from your 529 plan and how
much to take out — and there are ways to time your withdrawals for maximum advantage.
It’s important to coordinate your withdrawals with the education tax credits (American
Opportunity credit and Lifetime Learning credit). That’s because the tuition expenses that
are used to qualify for a credit can’t be the same tuition expenses paid with tax-free 529
funds. A tax professional can help you sort this out to ensure that you get the best overall
results. It’s also a good idea to wait as long as possible to withdraw from the plan. The
longer the money stays in the plan, the more time it has to grow tax deferred.
Note: Before investing in a 529 plan, please consider the investment objectives, risks, charges,
and expenses carefully. The official disclosure statements and applicable prospectuses, which
contain this and other information about the investment options, underlying investments, and
investment company, can be obtained by contacting your financial professional. You should
read these materials carefully before investing. As with other investments, there are generally
fees and expenses associated with participation in a 529 plan. There is also the risk that the
investments may lose money or not perform well enough to cover college costs as anticipated.
Investment earnings accumulate on a tax-deferred basis, and withdrawals are tax-free as long
as they are used for qualified education expenses. For withdrawals not used for qualified
education expenses, earnings may be subject to taxation as ordinary income and possibly a
10% federal income tax penalty. The tax implications of a 529 plan should be discussed with
your legal and/or tax professionals because they can vary significantly from state to state.
Also be aware that most states offer their own 529 plans, which may provide advantages and
benefits exclusively for their residents and taxpayers. These other state benefits may include
financial aid, scholarship funds, and protection from creditors.
The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and its advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member
FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Advisor. IFP and Hitchcock Maddox Financial Partners are not affiliated. Insurance and annuity products are offered through IFP Insurance Group LLC., a licensed insurance agency and wholly owned subsidiary of Independent Financial Partners.
Neither IFP Advisors LLC, IFP Securities LLC, dba Independent Financial Partners (IFP), nor their affiliates offer tax or legal advice. Any potential tax advantages or benefits will depend on your circumstances. Consult your tax professional and/or legal expert about your individual tax situation and visit IRS.gov to learn more. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not
take into account the particular investment objectives, financial situation, or needs of individual investors. Securities offered through IFP Securities, LLC (“IFP Securities”) a broker-dealer registered with and a member of the Financial Industry Regulatory Authority (FINRA)/SIPC Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a
Registered Investment Advisor. IFP and Hitchcock Maddox Financial Partners are not affiliated.