College is one of the biggest expenses we have in the United States, and whether you’re thinking about your children’s or grandchildren’s future education, money has a whole lot to do with it. For this reason, the 529 plan was invented, as a way to help caregivers put aside money to help their children attend college one day.
Although initially aimed at paying for higher education costs, is it possible to have a 529 plan as part of your retirement savings strategy?
A 529 plan can be used as a huge tax saving possibility whether you’re going to use it for yourself, your children, or your grandchildren. By investing money into a 529, you’re creating a haven for potentially hundreds of thousands of dollars that would otherwise be taxed by the government.
There’s a lot to take into consideration before you start throwing money at a 529 retirement plan though, and just like any other retirement investment option you have to understand all of the facts.
We’re going to explore the 529 plan, what exactly it entails, and the ways it can help earn more money for retirement, giving you a whole new way of saving money that you never thought possible.
What Exactly is a 529 Plan?
These plans were created in 1986 by a Michigan governor who wanted a way for parents to save for the high costs of college tuition.
From there, the plans gained traction and they’re now a popular tax-advantaged investment vehicle that could benefit millions.
There are two different types of 529 plans, a prepaid plan and savings plan.
A prepaid plan lets the owner purchase credits for tuition at today’s prices at preselected educational institutions across the country, to be used at a later date.
A savings plan grows its money by investing in things like mutual stocks and is based on their performance.
Parents or caregivers can put tax-deferred money aside into these plans which is then used by a beneficiary at a later date for education expenses.
These include tuition, supplies, and fees, and well as room and board for those that quality as half time students as a minimum.
Over the years, the money in the plan grows and by the time your children or grandchildren are ready for their higher education, it can be withdrawn tax free.
How Does a 529 Plan Affect Taxes?
Taxes play a major role in why these plans are so popular for retirement, and both contributions and distributions are affected.
When you contribute to a 529 retirement plan, you may be eligible for various tax benefits like deductions from your payable state income tax.
Anything you contribute to these accounts will be taken from your taxable estate, giving you a huge break in your potential tax payments.
When you withdraw from a 529 plan, you’ll be able to do so without paying federal or state tax in most cases.
The stipulation is that these funds must be used for expenses for qualified higher education, though.
Anything you take from your account that isn’t used for these purposes will be charged the standard income taxes as well as an additional 10 percent federal tax penalty.
The biggest benefit when it comes to taxes in this plan is that anything you earn in these accounts will grow over time as tax free earnings.
If you start early and contribute regularly, there’s potential to grow your money exponentially, and even if you end up withdrawing money at a later date, not for educational expenses, you may still come out on top.
Are There Other Fees Involved with These Plans?
The fees included in a 529 plan will vary depending on the plan with factors like investments, where it was purchased, and the details of the plan itself all having an impact.
Before choosing a 529 plan, whether you purchased it directly or used a broker, you should fully understand the details and offerings before you commit.
A prepaid plan will usually have fees relating to administration costs and enrolment, whereas a savings plan is more detailed.
Savings plans include costs like administration, enrolment, and management fees as there are ongoing investments to consider.
If your state offers a direct-sold 529 plan, these usually work out to be cheaper, and there are additional ways to save money like opting for electronic correspondence or online enrolment.
Who Can Contribute to 529 Plans?
A 529 plan is designed to assist a primary beneficiary, which is the child or teenager who plans on attending some form of a higher education institution.
One reason why people decide to invest in a 529 retirement plan when compared to something like a Roth IRA is the contributions.
In a Roth IRA, only the owner of that plan is able to make contributions, but with a 529, anyone is able to put money into it them to benefit the beneficiary.
In addition, there’s no income limit to who can use a 529 plan which makes them especially attractive.
Compared to a Roth IRA where there are limits in place stating contributors must have earned income in that specific year when they contributed, there are no such restrictions with a 529 plan.
What Happens to a 529 Plan If It’s Not Used?
Whether you use a savings plan or prepaid tuition, there’s no real way to guarantee that the beneficiary you’ve been putting money aside for will actually attend college one day.
Therefore, people are concerned about what could happen to the funds in their 529 plan if they don’t end up using them for education costs.
It is possible to change the beneficiary of a 529 plan to someone else within the original beneficiary’s family.
This way, even if the original person doesn’t end up using it, the funds can be transferred to someone else, and even you as the person who set up the account.
If nobody in the family uses it at all, the money can be withdrawn, but with some penalties.
You’ll be liable to pay state and federal taxes on the balance and in most cases, will have to pay an additional 10 percent federal tax as a form of penalty.
Some people choose to leave the money in the 529 plan until they’re certain it won’t be used for education costs, and during this time it’s able to grow even more.
What Restrictions Are There in a 529 Plan?
Like all other retirement savings vehicles, there are restrictions involved with a 529 plan that you need to be aware of.
Most importantly is the maximum amount of contributions allowed in each state, depending on the estimated costs of attending one of the more expensive colleges.
Depending on the state, these contribution limits range between $235,000 and $520,000.
However, even though there are limits in place, these aren’t enforced on a strict level.
Even if your 529 plan ends up going over the allowed limit, you won’t be liable for any taxes or penalties.
The only restriction is that you won’t be able to continue making contributions until the balance falls back below that line.
Another thing to keep in mind is that 529 plans can be purchased in multiple states for the same person.
You might currently reside in one state and have a plan there, but decide to invest in a plan for another state with good colleges.
You can effectively have many plans in place for the one beneficiary without any restrictions.
What Are the Benefits of a 529 Retirement Plan?
The benefits of this type of retirement plan are what make it such a smart investment option, but one that is still undiscovered by many future retirees.
Here are just some advantages you’ll find when you create a 529 retirement plan for yourself:
- Anything you earn with investment growth in a 529 plan is tax-free and the money will not be taxed at all if it’s withdrawn for education purposes.
- Some states offer specific tax breaks for contributions made to a 529, and you can choose a state’s plan that does if yours doesn’t.
- You retain full rights of the account and have the freedom to change the beneficiary or withdraw the money if you choose.
- A 529 plan is one of the easiest ways to save money without any effort, so you can set one up when the beneficiary is young and forget it about it until it’s time to withdraw.
Things to Remember With a 529 Plan
529 plans can be tricky when you consider all of the rules and regulations, but they can be a powerful investment tool if used the right way.
Keep these facts in mind when you’re trying to determine whether a 529 retirement plan would be right for you.
- Shop around when choosing a plan because they come with different fees, contribution limits, and investment options.
- Anything you contribute to a 529 plan will not be part of your taxable estate and you can contribute up to $15,000 a year without penalties.
- Although technically treated as a gift for tax purposes, any money you put into a 529 plan will remain under your control entirely.
- Every five years you will be able to make five years’ worth of tax-free gifts, upping the limit to $75,000 and giving you the potential to save a lot on estate tax.
A 529 plan is a great option for retirement but one that comes with many questions and uncertainties.
We’ve answered some common queries about these plans and how they might affect your future savings.
Can You Lose the Money in a 529 Account?
Even if the money isn’t used by the original intended beneficiary, there’s no way that you can lose money in a 529 plan account.
Other options include transferring to another beneficiary, using the money yourself for education, or withdrawing and paying some penalties and taxes.
Do You Earn Interest From a 529 Plan?
A savings plan will be able to earn interest over the years but it might also be charged fees that negate this.
Regardless of the amount you invest in the plan each year, everyone will earn interest at the same rate.