529 Plans

By Linda Leitz - Last updated: Friday, June 2, 2017 - Save & Share - Leave a Comment

If you want to contribute to the higher education of a loved one, a 529 plan might be worth considering.  It can be a way to put away money for this education goal with some good tax breaks.

Money in a 529 plan can be withdrawn for qualified education expenses for the designated beneficiary from an eligible education institution. The designated beneficiary is the potential student. This is often a child or grandchild. Contributions to the account are considered completed gifts to the beneficiary, however the beneficiary can’t withdraw the money. That’s up to the custodian, which can be the contributor to the account. Qualified education expenses are tuition, fees, books, supplies, equipment, room, and board required for education for a beneficiary who is enrolled at least half time at an eligible education institution. The equipment can include a computer and peripherals for education. To find an eligible education institution, you can look at the Free Application for Federal Student Aid, FAFSA, which is available at fafsa.ed.gov. This list includes universities, colleges, and trade schools.

One of the most tax efficient uses of a 529 plan is to begin investing as soon as the student is born and issued a Social Security number, for the account application. Growth from the money you invest is not subject to income tax if withdrawals are used for qualified education expenses. For example, if you invest $1,000 a year for 16 years and get a 6% return, you’d invest $16,000 and have over $27,000. You could save that money for education outside a 529 plan, but you’d pay tax on that growth. If you are a Colorado resident and put the money in the Colorado 529 plan, you’ll also get a state income tax deduction.

What if your potential student doesn’t pursue higher education? If withdrawals are not made to cover qualified education expenses, you will pay ordinary income tax on the growth and a 10% penalty. There might be some other alternatives to paying taxes and penalties. The beneficiary can be changed to a family member of the designated beneficiary, with family including siblings, step siblings, aunts, uncles, cousins, children, parents, or in-laws. If the student receives a scholarship from an eligible education institution, a withdrawal from the 529 plan in the amount of the scholarship can be subject to income tax, but not the 10% penalty.

If paying for education for more than one student in a family is something you’re considering, a 529 plan may be a good vehicle to fund education. If the funds aren’t needed for one student, they can be transferred to a relative. If you don’t mind the money staying in the account for a while, the funds could even be used for the next generation. But if the chance of taxes and penalties on withdrawals are a big concern, be careful before contributing to a 529.

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