ABC’s of Educational Savings Accounts
Dustin A. Husarik, CFP®
Vice President – Financial Advisor
Magnan Family Wealth Management
A 529 college savings account is a tax-advantaged investment plan designed to encourage saving for future education costs. Named after Section 529 of the Internal Revenue Code, these accounts are a popular choice for parents and grandparents looking to save for a child's college expenses.
There are two main types of 529 plans: prepaid tuition plans and education savings plans. Prepaid tuition plans allow account holders to purchase credits at participating colleges and universities for future tuition and mandatory fees at current prices, effectively locking in tuition costs and protecting against inflation.
Education savings plans, on the other hand, work more like a traditional investment account, where contributions are invested in mutual funds or other investment products. The earnings grow tax-deferred, and withdrawals for qualified education expenses are tax-free. Funds can be used at most accredited colleges within the United States.
While the federal government does not provide a tax deduction for contributions to a 529 plan, many states offer state income tax deductions or credits for contributions to their 529 plans. The availability and amount of these tax benefits vary by state. For instance, Illinois allows a deduction of up to $10,000 per year for individuals, and up to $20,000 per year for married couples filing jointly, on their state income taxes for contributions to a 529 plan. These tax benefits can make 529 plans even more attractive as a savings vehicle.
One of the most significant advantages of a 529 plan is the power of compounding. Compounding refers to the process where the earnings on an investment generate their own earnings over time. This exponential growth can significantly increase the value of the account, especially when contributions are made regularly, and the funds are left to grow over a long period. For example, if a parent starts contributing $250 a month to a 529 plan when their child is born, and the plan earns an average annual return of 7%, the account will grow to approximately $105,000 by the time the child turns 18. This amount could cover a significant portion of college expenses, reducing the need for student loans and the associated financial burden.
College tuition costs have been rising steadily for decades, often outpacing inflation. By starting to save early in a 529 plan, families can take advantage of both tax benefits and the power of compounding to help offset these rising costs. Even if the amount saved does not cover the entire cost of college, it can still make a substantial difference, potentially reducing the need for loans and making higher education more affordable.
529 college savings accounts offer a strategic advantage for grandparents in both gifting and estate planning. By contributing to a 529 plan, grandparents can provide a significant financial gift to their grandchildren’s education while potentially reducing the taxable value of their estate.
Contributions up to $18,000 per year per grandchild (or $34,000 for married couples) qualify for the annual gift tax exclusion in 2024. Additionally, a special five-year election allows up to $90,000 ($180,000 for couples) to be contributed in one year without incurring gift taxes. This can be an excellent tax strategy for those of you that may face potential Estate Taxes.
One of the flexible Features of 529 college savings accounts is the ability to change the beneficiary without incurring taxes or penalties. If the initial beneficiary, such as your child, decides not to attend college, you can transfer the funds to another eligible family member, including siblings, cousins, or even yourself for education purposes. This flexibility ensures that the funds can still be utilized for education expenses within the family.
New in 2024 is the 529 to Roth IRA rollover. This new rule allows 529 plans that have been opened for 15yrs to rollover up to the IRA Annual Limit per year up to a lifetime maximum of $35,000. The IRS has provided limited guidance on rules around eligibility for accounts that have been opened for 15yrs but have changed beneficiaries. (See Disclosures). We will continue to remain at the forefront of the ever-changing landscape and provide updates as we gather new information.
Disclosures:
Note that the contribution may not exceed the aggregate of contributions and earnings in the account more than five years before the rollover and the Roth IRA owner must have earned income at least equal to the amount of the rollover
Please consider the investment objectives, risks, charges and expenses carefully before investing in a 529 savings plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor, read it carefully before you invest. The availability of such tax or other benefits may be conditioned on meeting certain requirements.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC. Magnan Family Wealth Management is a separate entity from WFAFN