How to Use a 529 Plan for Tax Savings

Financial planning is often associated specifically with retirement planning and while retirement may represent a huge consideration, there are many other aspects of wealth management that require careful decision making. For many people, college can be among the largest expenses they’ll face, right behind their mortgage.  Regardless of the specific circumstance, a 529 plan can make a lot of sense when trying to accumulate money to pay college tuition and help maximize tax advantages.

What is a 529 plan?

A 529 plan is an investment account you can set up specifically to save for your child’s college expenses. 

Since there are so many differences in each personal situation, and because 529’s have differences depending on your state, there are many questions you’ll need answered.

What is the advantage of a 529 plan for saving for college?

The biggest benefit is in tax-deferred growth. Once you open a 529 plan, and choose the investments therein, there will be no federal taxes levied on the growth, nor will withdrawals be taxed as long as the withdrawal is for a qualified expense.  This may differ from other investment accounts that may incur taxes on withdrawal, like from some types of retirement accounts.

In Colorado, a 529 plan can help save on taxes, since your contributions to a 529 are deductible for state taxes.  That means you can reduce your state tax liability and also grow your investments tax deferred. 

How much of a 529 is tax deductible?

Your tax deduction for 529 plans varies by state.  It will be important for you to discuss the issue with your financial planner and get current and accurate information for your particular state.  Not all states allow for a tax deduction, and there is no deduction for your federal tax bill. 

What happens if not all the money in a 529 is used for college?

The tax-deferred growth and potential tax deduction can only be realized if the money from a 529 plan is used for a qualified expense, which includes tuition, room and board, fees, books, and computer equipment and supplies. If you don’t use all of the money in the 529 account on one child, you’re able to transfer the money to their sibling.  

If you take a withdrawal from a 529 account and do not use all of the proceeds for qualified expenses, you may be in for an income tax.  Because of this, the need for proper care and planning cannot be overstated, and we recommend that you involve a Certified Financial Planner^TM to help you set up your contributions and plan your withdrawals.

How does money in a 529 grow?

While often referred to as a “college saving plan,” a 529 is really an investment account.  Once deposited, you can choose from a variety of investment vehicles, with different choices available in each state.

Each state has different 529 plans available and each plan may have different investment options.  For example, in some Colorado 529 plans, you may have access to the Vanguard Group fund family, or to MetLife funds.  Regardless, your money can be invested for better growth opportunities, rather than sitting in a savings account earning small amounts of interest.

How much does it cost to set up a 529 plan?

There are three areas where you may encounter fees while setting up your 529 plan.  First, there may be minimum contributions required to open the investment account.  You may encounter account minimums from zero dollars all the way up to several hundred dollars.  Second, there can be fees associated with the investments in your 529 plan.  Your investment choices should be made carefully with this in mind. Just like any investment account, expenses can eat into gains, so you should consider this before making your allocation choices.  Lastly, you should always get the help of a qualified financial planner before you set up a 529 plan.  Getting professional help is always recommended, especially when there are so many complexities involved.

Are there limits to how much money you can put into a 529 plan?

The maximum contributions to a Colorado 529 is $400,000 for each beneficiary.  This number has gone up over time and will likely increase.

Should everyone sign up for a 529 plan?

If you have children and want to help them pay for their college education, a 529 can be an excellent way to do it, but it’s not for everyone. As you’ll note from the information here, there are many variables that need to be evaluated before making a decision.  One way to start is to call Dechtman Wealth Management.  Make an appointment to meet with a Certified Financial Planner^TM professional to discuss your personal situation and your goals.  With the right planning and help, you’ll make informed decisions for your financial future.

Disclosures for this blog:

If an account owner or the beneficiary resides in or pays income taxes to a state that offers its own 529 college savings or pre-paid tuition plan (an “In-State Plan”), that state may offer state or local tax benefits. These tax benefits may include deductible contributions, deferral of taxes on earnings and/or tax-free withdrawals. In addition, some states waive or discount fees or offer other benefits for state residents or taxpayers who participate in the In-State Plan. An account owner may be denied any or all state or local tax
benefits or expense reductions by investing in another state’s plan (an “Out-of-State Plan”). In addition, an account owner’s state or locality may seek to recover the value of tax benefits (by assessing income or penalty taxes) should an account owner rollover or transfer assets from an In-State Plan to an Out-of-State Plan. While state and local tax consequences and plan expenses are not the only factors to consider when investing in a 529 Plan, they are important to an account owner’s investment return and should be considered when selecting a 529 plan.

Tax laws are complex and are subject to change. This information is based upon current tax rules in effect at the time this was written.

Investments in a 529 Plan are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so an individual may lose money. Investors should review a Program Disclosure Statement, which contains more information on investment options, risks factors, fees and expenses and possible tax consequences. Investors should read the Program Disclosure Statement carefully before investing.

The 529 Plan Program Disclosure contains more information on investment options, risk factors, fees and expenses, and potential tax consequences. Investors can obtain a 529 Plan Program Disclosure from their Financial Advisor and should read it carefully before investing.