Do you have children? Has fear struck your heart at the thought of paying for college one day? If potentially down the road your children may attend college, you will want to start saving for these expenses and the best way to do it is in a 529 account.
So, what is a 529 account?
According to the Securities and Exchange Commission, “a 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs.” 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. Basically, it is an account where you can save money for education expenses. There are two types, prepaid tuition plans and education savings plans. In our opinion the better option is the education savings plan because this is an investment account you open that can include mutual funds or exchange-traded funds and can generally be used at any college or university as well as now with the new tax law for up to $10,000 per year for tuition at K-12 schools. Prepaid tuition plans are generally for a specific state, which means that if you move or your child wants to go out of state to college, they will likely receive a decrease in the benefits.
Tax Implications for your 529 account
You can open and invest in a 529 plan sponsored by any state, residency generally does not matter. When you open and invest in a 529 plan there are tax advantages. Many states offer tax benefits for contributions to a 529 account and when you withdraw the money and use it for qualified expenses the earnings are not subject to federal income tax and in many cases state income taxes. If you use the money for something else, you will have to pay both federal and state taxes on the earnings as well as an additional 10% federal tax penalty.
Typically, there are tax breaks on the state level when you contribute to a 529 account. However, it must be a state plan for the state you file in. For example, Virginia residents with a VA 529 account are eligible for up to a $4,000 per account deduction on your state tax return. If it is another state’s 529 plan, you will not be able to count it on your Virginia returns. Check with your state’s tax code to see what deductions you could be eligible for when making contributions to a 529 account.
How to use your 529 account
When it is time to pay for college and you want to use your 529 money you have options. The biggest expense is tuition, room & board, and fees, followed by books and supplies. A few other things are qualified expenses as well, such as computers, internet access, and computer software for educational purposes. When it comes time to pay for those expenses, there are a few ways you can withdraw money from your 529 account to use it. The first is to have the money paid directly to the institution. If you know the amount and can plan far enough ahead you can have the institution that holds your money send it directly to the college. You can also pay the bill then “reimburse” yourself by having the 529 money paid directly to your or the beneficiary (whoever spent the money). You should keep receipts for all transactions that you are paying for using 529 money and any money withdrawn must be spent in the same calendar year that you take it out.
What happens if your child decides not to go to college? Good news! You can transfer the money to another child for their education expenses or you can use it for your own education expenses.
Want more information?
This is just a brief highlight of 529 plans. If you want more information on how to use money already invested or want a better understanding of 529 plans, make an appointment to come in and have a discussion about your situation.