Common Questions and Misconceptions About 529 Plans

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Many individuals have questions about 529 plans. A 529 plan is a type of investment account. These accounts help people save money for various purposes. Savers enjoy tax benefits when using a 529 plan for education expenses. Qualifying expenses include tuition, room and board, and school fees and supplies.

Students can use these plans to repay up to $10,000 in student loans. Individuals can open 529 plans for themselves or another designated beneficiary. These plans don't significantly impact financial aid eligibility.

Purchasers can apply for direct-sold 529 plans through plans' websites. They can also buy an advisor-sold 529 plan from licensed financial advisors.

Do you have questions about 529 plans? Read on for answers to common 529 plan questions. This page also explores 529 plan myths.

To Whom Can I Transfer the Money in a 529 Plan?

Sometimes 529 plan beneficiaries don't use all their funds. In these cases, the account owner can transfer money to eligible relatives. These can include immediate, extended, or step family members. In-laws and spouses of family members may also qualify as eligible relatives. Account owners can also name themselves as beneficiaries.

Some 529 plans allow account holders to transfer money to guardians or housemates. These may include live-in partners, legal guardians, or foster or adoptive parents. People who maintain residency with the beneficiary for most of the tax year may qualify to receive the funds.

How Much Can You Contribute to a 529 Plan?

Most 529 plans don't limit annual contribution amounts. However, if you contribute over $15,000 annually per recipient, you must report it on your taxes. This can count against lifetime estate and gift tax exemptions.

Potential 529 purchasers should also consider maximum aggregate limits. These limits restrict 529 contributions to no more than the total estimated cost of higher education in the state where the plan is purchased. These amounts vary by state. For example, Mississippi and Georgia allow contributions of up to $235,000. Missouri allows up to $550,000.

Do You Get a Tax Deduction for Contributing to a 529 Plan?

A 529 plan is like a Roth IRA and 401K plan. These plans place after-tax contributions into investments such as mutual funds and exchange traded funds. Investments grow on a tax-deferred basis until withdrawn. Recipients can withdraw funds tax free when using them for qualified higher education expenses.

Contributors cannot deduct contributions from their federal income taxes. However, over 30 states provide state tax credits and income tax deductions for 529 contributors.

Are There Estate Tax Benefits for 529 Plans?

The government treats 529 plan contributions of up to $15,000 as completed gifts eligible for the annual gift tax exclusion. Federal estate taxes don't apply to 529 plan assets. This means that contributing to 529 plans reduces the purchaser's taxable estate.

Many family members or guardians use 529 plans in estate planning. Some grandparents open 529 plans for their grandchildren. If the grandparent dies before the intended recipient reaches college, the account's ownership gets transferred to a named successor. If no successor exists, a probate decides on a successor. Estate or inheritance taxes may apply. This depends on the 529 plan and the state in which the account owner lived.

Can I Have 529 Plans From Multiple States?

Most 529 plans permit purchasers to open the plan in any state. Neither purchaser nor beneficiary must live in that state at the time of purchase. Plan purchasers can buy 529 plans for the same beneficiary in multiple states. Some people purchase 529 plans in multiple states due to state tax deduction limits. Other reasons may include diversifying investment portfolios.

Can You Move Money Between 529 Plans?

Yes. Plan owners can take out the money and pay a withdrawal penalty. They can avoid this penalty by moving the money to another beneficiary. Most 529 plans allow owners to transfer money between 529 plans in the same state. Many plans permit transfer of 529 plan funds to plans in other states. However, the purchaser may need to pay income tax on contributions made in the previous state.

Plan owners who move out of state may roll over their 529 plan to their new state. This applies if the plan has the same beneficiary. Account holders can usually roll over their 529 plan once a year without accruing income tax and penalties.

Is There a Penalty for Withdrawing From My 529 Plan?

Most 529 plans allow direct distribution of payments to beneficiaries, account holders, or eligible educational institutions. People withdrawing funds may need to report withdrawals and contributions on their tax returns. Rules vary by plan. Account owners and beneficiaries should consult their particular plans' distribution guidelines.

Account holders face withdrawal penalties if they remove funds for purposes unrelated to education. They may pay a penalty of around 10% of the plan total.

Misconceptions About 529 Plans

If you have questions about 529 plans, you're not alone. Understanding these plans can get confusing since guidelines vary by state and plan. Read on for clarification on some common myths about 529 plans.

Account holders can withdraw unused portions of 529 plans. The funds don't go away. Plan owners can use this money for any purpose. However, they face a withdrawal penalty of about 10% of the total if they use the money for non-qualifying expenses.

The fund owner also usually pays federal (and sometimes state) income tax on the earnings portion of such funds. Many plans waive the withdrawal penalty in certain situations. These include if the beneficiary becomes disabled or dies, attends a military academy, or receives a tax-free scholarship.

Some people think you can only open a 529 plan in the state where you live. This applies to prepaid tuition plans, but not to most 529 plans. Just six states restrict their direct-sold 529 plans to state residents. Individuals can still buy advisor-sold 529 plans in these states.

Most states offer advisor-sold plans to anyone. Purchasers can choose from many 529 plan vendors. However, in many states, only individuals who buy in-state 529 plans receive state income tax deductions and tax credits.

Anyone can open a 529 plan, including people unrelated to the beneficiary. Some people open a custodial 529 plan account for an unrelated child. To open a plan, you need the beneficiary's birthdate and Social Security number or individual taxpayer identification number. Purchasers without this information sometimes designate themselves as beneficiaries. They then change the beneficiary to another person later.

Contributors can give funds to accounts opened by or for people unrelated to them. Contributors usually pay by check or electronic payment. Some plans offer gifting platforms that make it easy to give.

Many individuals don't think saving a little per month will make a big difference. However, small contributions add up, especially when the account purchaser buys a 529 plan when the beneficiary is young. Parents or guardians who buy 529 plans can start with a low monthly contribution and then increase that amount when they gain more discretionary income. Compound interest accrues to each contribution and amasses on investment earnings and interest.

Many 529 plans charge an initial setup fee but allow low monthly contribution amounts. Starting with a low amount often makes sense for new parents or guardians. Many 529 purchasers later increase their contribution amount when they have more money.

Keep in mind that 529 plans may place top-end limits on contribution amounts that exceed gift tax limitations. This keeps families from storing large amounts of wealth in tax-exempt 529 savings plans.

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