1. Tax benefits
Investments in 529 plans grow tax-deferred, which means you don’t have to pay federal state taxes on the money you invest in them.
Distributions are also tax-free if used to pay for qualified education expenditures, including college tuition and fees, books and supplies, and some room and board costs.
You can even use tax-free distributions for up to $10,000 in K-12 tuition each year and up to $10,000 in student loan repayment per beneficiary and sibling.
In most states, eligible 529 plan distributions are not included in your taxable income, and many states offer a state income tax deduction or credit for donations to 529 plans. The only college savings plan with state tax benefits is the 529 plan.
You don’t have to use your home state’s college savings plan for tax benefits, even if your state has residence requirements.
The exception may be if your family has pre-paid their tuition.
Most states do not allow you to claim their tax benefits if you choose another state’s college savings plan. These seven tax parity states, however, let you claim benefits for a 529 plan based in any state:
If you’re unsure of your own state’s rules or need further tax advice on the benefits of a 529 plan, please consult your tax advisor.
2. Low maintenance
Investing in a 529 plan requires very little work on the part of the account owner.
There are two ways to open a 529 plan account: online or through a financial counselor.
Families who prefer to “set it and forget it” might choose an automated investing plan tied to a bank account or payroll deduction plan. In these circumstances, a program manager is responsible for the day-to-day management of the 529 plan’s investments.
Plus, beneficiaries don’t have direct access to the account. As the donor/account owner, you can rest assured that the money goes only to what you intend — education.
Although there’s very little maintenance on your part, you can start off by choosing a portfolio that will grow with your child or grandchild’s age. Many 529 plans begin with riskier investment portfolios during the beneficiary’s early childhood and transition to steadier investments as the child ages.
3. High contribution limits
Like Roth IRAs and Coverdell Education Savings Accounts (ESA), 529 plans do not have yearly contribution limits or large aggregate limits. Depending on where your 529 plan is based, state-specific maximum aggregate limitations range from $235,000 to $529,000.
In terms of taxation, donations to a 529 plan are considered made to the chosen beneficiary, which means these contributions are only taxed if they exceed the federal gift tax exclusion. The annual gift tax exclusion will be $15,000 (for individuals) and $30,000 (for married filing jointly) in 2021.
There is also an option to contribute up to $75,000 in one tax year without paying taxes on the gift if the donation is treated as if it were spread over 5 years.
4. Only a minor impact on financial aid
A 529 plan owned by a dependent student’s parent or a dependent student is recorded as a parental asset and has a minor impact on financial aid eligibility.
On the FAFSA, distributions from parent and student-owned accounts for education expenses are not recorded as income.
Regardless of household income or contribution amount, all 529 plans provide the same benefits to all families. No matter where you reside or where your child will attend college, you can invest in practically any 529 plan.
You can change your 529 plan investment options 2 times within any given calendar year. With the same beneficiary, you can rollover funds from one 529 plan to another.
If you change the beneficiary, your 529 plan isn’t subject to those limits.