Planning for the Future with 529 Plans

If you have children in your family, planning for college and the expenses associated with an education can be daunting. A 529 plan may be a valuable investment vehicle when it comes to preparing for the hefty costs of college. These state-sponsored plans aren’t merely about setting funds aside; they’re about maximizing tax advantages while planning for future education expenses. In this newsletter, we will review 529 plans and how they may be an effective tool to save for future college expenses.

A 529 plan is an investment account designed specifically for education savings. Named after Section 529 of the Internal Revenue Code, these plans are offered by states and educational institutions alike. There are two main types: prepaid tuition plans and education savings plans. Prepaid tuition plans allow you to pay for future tuition costs at today’s rates, while education savings plans function more like a traditional investment account.  Both allow an individual to invest money that can later be withdrawn tax-free for qualified education expenses as needed.

Contributions to 529 plans are made with after-tax dollars, meaning you don’t get a federal tax deduction for your contributions. However, the earnings within the plan grow tax-free, and withdrawals for qualified education expenses are also tax-free at the federal level. Additionally, many states offer tax deductions or credits for contributions to their own 529 state sponsored 529 plans, providing further incentives for participation. These plans typically offer a range of investment options, allowing you to choose a portfolio that aligns with your risk tolerance and time horizon.

One of the key benefits of 529 plans is their flexibility. Funds can be used at eligible educational institutions nationwide, including colleges, universities, and vocational schools. Qualified expenses include tuition, fees, books, supplies, and even room and board for students enrolled at least half-time. Additionally, recent changes to the tax code have expanded the use of 529 funds to cover K-12 education expenses, offering even more flexibility for families with educational needs at different levels.

To make the most of your 529 plan, it’s important to start saving early and contribute regularly. Even small contributions can add up over time, thanks to the power of compounding returns. Many plans offer automatic contribution options, allowing you to set up recurring transfers from your bank account which can automate your savings process. By making saving a habit, you can build a sizable education fund which will help to offset the cost of education when the time comes.

As your child approaches college age, it’s essential to review your investment strategy and adjust your asset allocation accordingly. Many 529 plans offer age-based investment options that automatically shift to more conservative investments as the beneficiary gets closer to college age.  This can help to protect your savings from market volatility.

Now, let’s discuss an important aspect of 529 plans: the 5-year rule and contribution limits. This rule has two main implications. First, individuals can make a lump-sum contribution of up to five times the annual gift tax exclusion amount in a single tax year without triggering gift taxes.  This is true if they don’t make additional contributions to the same beneficiary over the next four years. This means that as of 2024, an individual could contribute up to $90,000 ($18,000 annual exclusion x 5) in one year without incurring gift taxes. However, they would need to wait for the next four years before making any further contributions to that same beneficiary to avoid triggering gift taxes.

Second, the 5-year rule affects the tax treatment of withdrawals from the 529 plan. Withdrawals used for qualified education expenses are generally tax-free. However, if a withdrawal is made within five years of a lump-sum contribution and is not used for qualified expenses, it may be subject to taxes and penalties on the earnings portion. Understanding these rules is essential for effective planning and maximizing the benefits of your 529 plan contributions.

529 plans may be an advantageous savings vehicle for future education expenses. If you have any questions on how these plans work or would like to begin saving for your children, grandchildren, nieces, or nephews, please reach out to the CERTIFIED FINANCIAL PLANNER™ professionals at The Normandy Group, and we would be happy to assist. Whether you are just starting your saving journey or nearing the college years, it’s never too late to start saving. Start planning today and pave the way for a brighter future for your loved ones!

Best regards,

Derek Landis, CFP®


Download our free eBook “6 Simple Steps to a More Confident Retirement”:

eBook cover, older adult couple reviewing paperwork making a financial decision


Derek Landis