Like most people, you probably have many financial goals – short-term ones, such as a vacation or a major purchase, and long-term ones, such as a comfortable retirement. And if you have young children, you can add another goal to your list: paying for education. This goal may be more complicated if you’re still paying off your own student loans, as is the case for many parents.
Here’s one strategy you might consider: setting up a 529 plan. A 529 plan is a state-sponsored education savings plan that can be used toward higher education expenses, trade schools, apprenticeships – and, in some states, elementary, secondary and religious schools – for the account beneficiary. A 529 plan offers account owners tax advantages, flexibility and control.
Beneficiaries and contributors
Anyone – at any age – can be the beneficiary of a 529 plan. As the account owner, you control the account and choose the beneficiary. If your original beneficiary decides not to attend college, you can generally change the beneficiary to another eligible family member.
And, anyone – parents, grandparents, other relatives, friends – can contribute to a 529 plan, regardless of income.
529 plan tax benefits
Earnings from 529 plans accumulate tax free, and withdrawals are free of federal taxes and penalties as long as they are used for qualified education expenses. Qualified postsecondary education expenses include:
- Tuition and fees
- Required school supplies
- Room and board if the beneficiary is considered at least a half-time student (including off-campus housing equivalent to the cost of living on campus)
- Computers and related equipment (such as printers), internet access and educational computer software used primarily by the 529 plan beneficiary
In some states, qualified 529 plan withdrawals for federal tax purposes have been expanded to include up to $10,000 in tuition, per year, per beneficiary for public, private or religious elementary or secondary schools.1 Check with your financial advisor about your state's specific withdrawal guidelines for 529 plans. And consult with your tax professional for questions about the potential state tax consequences of paying for elementary or secondary school tuition expenses with 529 plan funds.
Seven states – Pennsylvania, Arizona, Missouri, Minnesota, Montana, Arkansas and Kansas – provide for state tax parity, which means you may receive a state income tax deduction if you live in that state and contribute to any state plan. And some states offer other benefits to in-state 529 plan investors, such as financial aid, scholarship funds and protection from creditors.
529 plan contribution limits
You can put large amounts into a 529 plan. Contribution limits depend on your state's plan but are typically more than $235,000. The 2022 federal gift-tax exemption allows you to give up to $16,000 per year per beneficiary, or $32,000 if you're giving as a married couple.
You could also choose to give up to five years of gifts in one year while still qualifying for the annual gift tax exclusion – a strategy known as “superfunding.” So, for instance, you could make a lump-sum contribution of $80,000 today2 ($16,000 x 5 years) per beneficiary without having the money count toward your lifetime estate and gift tax exemption. A couple can jointly give double this amount. And by putting a lump sum to work right away, a superfunding strategy can potentially help your child’s college savings grow faster. The contribution will represent a $16,000 gift in the current year and the next four years, if the donor contributes the full amount. The donor must elect this special treatment on a gift tax return filed and cannot make any other annual tax-free gifts to the same beneficiary in the five-year period following the gift. The completed gift is excluded from the donor’s estate for estate tax purposes. If the donor dies within the five-year period, a pro rata portion of the gift must be added back into the donor’s estate.
Contributions from friends or other family members to your 529 plan are considered gifts from that person and don’t affect your gifting limits. Friends or family members can also open their own 529 plans and name your child as the beneficiary – in fact, your child can be the beneficiary on multiple 529 plans.
What investments are inside a 529 plan?
When you contribute to a 529 plan, you will typically have a few different investment options. Here are some of the most common ones:
- Age-based portfolio – An age-based portfolio automatically adjusts its asset allocation – its investment mix – based on your beneficiary’s age, potentially lowering the investment risk as your beneficiary gets closer to college or another form of higher education.
- Target portfolio – A target portfolio, sometimes called an asset allocation portfolio, usually invests in two or more mutual funds. Most target portfolios will stick with a particular stock/bond mix over time, although the portfolio manager may rebalance the portfolio as needed.
You can change investment options in your 529 plan twice a year, assuming no beneficiary change. (The portfolio changes made in an age-based portfolio don’t count.) And whenever you change beneficiaries, you can also change your investment option.
Whatever type of portfolio you choose in your 529 plan should follow the proven investment principles of quality and diversification. You’ll also want a portfolio that aligns with your return objectives, risk tolerance and time horizon.
529 plans not confined to in-state schools
You’ve got flexibility in where you can use your 529 plan dollars. Regardless of the state in which the 529 plan was set up, you can use the money for qualified expenses at an eligible institution in any state. An “eligible educational institution” is any school offering higher education beyond high school that is eligible to participate in a student aid program run by the U.S. Department of Education including public or private colleges, universities, trade schools or other postsecondary educational institutions.
And you can also use a 529 plan to pay qualified costs for apprenticeships – such as fees, textbooks, supplies and equipment — as long as the apprenticeship program is registered with the U.S. Department of Labor.
Can a 529 plan be used to pay student loans?
Yes, up to a lifetime maximum of $10,000. Under the SECURE Act of 2019, 529 plan holders can now withdraw up to $10,000 from their plan to pay down qualified student loans penalty free. The $10,000 maximum is a lifetime limit for a beneficiary and each sibling. So, if your family has two children, you can take out a maximum of $20,000 to pay their student loans. (You cannot claim any student loan interest deductions paid with this money.)
Does a 529 plan affect financial aid?
Yes, but the impact is generally small. Regardless of whether the 529 plan is owned by the parent or the student, it is considered a parental asset, which generally has a lower impact on financial aid than other factors. For more information on your state's financial aid considerations, talk to your financial advisor.
You also might want to talk to a financial aid officer, as financial aid is a complex subject. For example, if a grandparent owns a 529 plan, the implications for aid are different than if a student or parent is the owner.
Don’t stop saving
The Biden Administration has proposed a student loan forgiveness program. Under this plan, the Department of Education will cancel up to $20,000 in debts for Pell Grant recipients and up to $10,000 for non-Pell Grant recipients. Borrowers can take advantage of this debt relief if their individual income is less than $125,000 ($250,000 for married couples).
The forgiveness program is only for debt held by the Department of Education and does not cover private student loans, including federal loans that are privately held. Loans obtained after June 30, 2022, are not eligible to be forgiven. So, don’t take out a new student loan with the expectation that it will be forgiven as part of this program.
Furthermore, there’s no guarantee the government will provide additional loan forgiveness in the future. The initiative is also currently being challenged in the court system.
To sum up: While the loan forgiveness initiative may be valuable to current borrowers, it should not serve as a reason to stop saving for college through a 529 plan or other methods.
Establishing a 529 plan
With so many variables affecting your education savings strategy, you should talk to your local Edward Jones financial advisor to gain their insight on your situation, your state's 529 plan and other education savings options. A financial advisor can help determine the right path for you based on your beneficiary's needs. Remember, the sooner you start saving, the better.
1If you live in a state that does not recognize the expanded use of 529 plan funds and will be required to adopt additional legislation regarding its 529 plan and state income tax incentives, and you withdraw funds before those states recognize the use of 529 plan funds for elementary or secondary school tuition, you may risk having to repay a state tax deduction you've already received, may face state taxes on the investment gains in the account and/or may incur additional penalties. Tax issues for 529 plans can be complex, so we recommend you consult a qualified tax advisor regarding your situation.
Withdrawals used for expenses other than qualified education expenses may be subject to federal and state taxes, plus a 10% penalty on the earnings portion of the distribution. State tax incentives and additional benefits may be available to in-state residents who invest in their home state’s 529 plans. Student and parental assets and income are considered when applying for financial aid. Generally, a 529 plan is considered an asset of the parent, which may be an advantage, in terms of receiving financial aid, compared to building savings in the student’s name. Make sure you discuss the potential financial aid impacts with a financial aid professional. This content should not be depended upon for other than broadly informational purposes.
Please consult your tax advisor about your situation. Edward Jones, its financial advisors and employees cannot provide tax or legal advice.
Edward Jones receives payments known as revenue sharing from certain mutual fund companies, 529 plan program managers and insurance companies (collectively referred to as “product partners”). For more information, see Revenue Sharing Disclosure.
2 2022 amount.