Education costs can be costly. There are many pieces to consider, such as tuition, books, room and board, and other smaller expenses that can burn through any savings like a wildfire. If you are planning ahead on education costs, it may be wise to look into getting a 529 Plan.
What is a 529 Plan?
529 plans are used as a valuable savings tool for education expenses with financial aid and tax benefits. What you invest is after-tax wages in a tax-deferred account. These funds then can be distributed for qualified educational expenses tax-free.
These plans work for these eligible institutions:
- Colleges or universities.
- Vocational schools.
- Other FAFSA-approved post-secondary schools.
There are restrictions to be aware of regarding what the money may be used to be determined a qualified expense. If you decide to withdraw money for something that isn’t qualified, you will have to pay ordinary income tax, along with a 10% penalty of the earnings.
Some examples of what it can be used for includes:
- Tuition and fees
- Room and board
- School supplies
- Special needs beneficiaries and services
For a 529 plan to be used for room and board, a student has to be enrolled in a qualified institution (as mentioned above) minimum half-time. For off-campus housing, the school has to set a maximum amount to the IRS to determine the cost of living. A part of room and board includes food expenses and meal plans. This is a common way that students use their 529 plans, and is one of the easiest to document.
Costs Not Covered
Fraternities and sororities are considered an extracurricular experience that does not qualify as an acceptable expense. If, however, a student has a meal plan through their greek organization, they could try to use it for this purpose under the same restrictions as meal plans.
No form of travel expenses are qualified. This includes costs incurred from studying abroad, owning a car, tickets, or other travel-related expenses.
Currently, student loans are not qualified as an expense. There is a loophole, but it can be tricky. First, you would have to pay a qualified expense with a student loan. In the same tax year, you would have to draw out money from a 529 plan that matches the same eligible expense.
To do this, you would have to use the same documentation and receipts from the student loan payment for the 529 withdraw payment. Only then can you take the money withdrawn from the 529 account to pay back the student loan.
Very limited international schools are qualified for 529 funding. To figure out which schools are eligible, you can use the Department of Education’s School Code Search Tool.
Standardized tests like the SAT and ACT are not qualified expenses. Prep courses in K-12 education, however, would be, sans materials and exam fees.
Types of 529 Plans
Each state has its own 529 plan, and you can invest in any state regardless of where you live. What it consists of is determined by the individual state, as long as it satisfied federal requirements.
Some have both types of plans, one based on prepaid tuition and one in college savings plans.
College Savings Plans
These plans are similar to a Roth 401(k) because you invest after-tax wages into a mutual fund or investment. The increase or decrease in value depends on the investment’s performance.
Prepaid Tuition Plans
These plans allow you to pay all in-state college education costs up-front and can be converted at either out-of-state or private colleges.
Using a 529 Plan
When you need to withdraw from your plan, you can distribute payments to the beneficiary, the account holder, or your educational institution. As previously mentioned, if you withdraw wages that aren’t qualified, you will have to pay a fee.
If a student does not use the money, the tax and penalty fee still occurs, unless it falls into one of these exceptions:
- The student attains a tax-free scholarship.
- The student becomes disabled.
- The student enrolls in a military academy.
In these events, all wages will be subject to taxes. To avoid this, you can change the beneficiary to a different, qualified person, hold it for future education should the student change his or her mind, further your own education, or exchange it into a savings account for a disabled person.
529 plans are growing, and so has grant use and debt financing. 529 plans show an increase at a similar rate to student loans. Using a 529 plan’s upcoming popularity paves the way for easier access into college for families who can’t otherwise afford it.
Most educational expenses are qualified for 529 payment. There are always opportunities to make sure everyone can get a better education and, as always, please don’t hesitate to contact us for any further information or questions you may have.