If you have young children or grandchildren, saving money for their college education may be among your top financial goals. And while the concept of college savings plans is fairly simple—sock away and invest money specifically for education expenses—these accounts can be surprisingly complex.
A 529 college savings plan is a tax-advantaged account for education savings. Much like a Roth IRA, after-tax contributions to a 529 plan can be invested and later withdrawn, tax-free, if used for qualified higher education expenses.
Here, we’ve assembled answers to the most frequently asked questions about 529 college savings plans.
Do I need to open a 529 plan in my own state of residence?
No. Anyone can open a 529 plan in any state, and the plan beneficiary can attend any accredited college, even if it’s located in a different state than is sponsoring the 529 plan. For example, a parent in Oregon can open a 529 plan in Utah which later funds college tuition in Ohio.
What are the key features Vista looks for in a 529 plan?
Nearly every state offers a 529 plan, so determining which plan is most appropriate can be a challenge. Also, many states offer in-state tax deductions for residents, which can tip the scales in favor of one’s home state. We also prefer plans offering “age-based” portfolios—those which automatically scale back investment risk as the beneficiary approaches college. This reduces the need for constant monitoring and rebalancing by the account owner.
How much do I need to save for college?
This depends on a number of factors, including the year a beneficiary will attend college and expected costs. Costs vary depending on whether an institution is in-state or out-of-state, public or private, or two-year or four-year—as well as the portion of costs you intend to pay.
According to College Board’s “Trends in College Pricing and Student Aid” report, national averages for the 2021-2022 academic year for a full-time undergraduate student range from $27,330 for public four-year in-state college to $55,800 for private four-year college. These figures include tuition and fees, room and board, books and supplies, transportation, and other expenses.
What are the tax advantages of paying for college with a 529 plan?
Contributions to a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free.
Additionally, several states provide incentives such as income tax credits for residents who make contributions to their states’ plans. In Oregon, residents who make contributions to the Oregon College Savings plan can earn an income tax credit up to $150 for single filers or $300 for joint filers. Annual income determines how much you need to contribute to earn the full tax credit.
Because tax benefits vary by state, be sure to check your state-sponsored 529 plan website to learn more.
What if the plan beneficiary doesn’t go to college?
In such an instance, unused balances can be transferred to a 529 plan for another family member (broadly defined), which could include you, other children, nieces/nephews, etc. Those beneficiaries can then tap funds in the 529 plan (tax-free) for higher education expenses.
What expenses will a 529 plan cover? What isn’t covered?
Use 529 plan funds for:
- Room and board, tuition and fees, books and supplies, computers, and software
- Payments on qualified education loans, including principal and interest, with a $10,000 lifetime maximum
- Expenses associated with registered apprenticeships (the program must be registered and certified with the Secretary of Labor under Section 1 of the National Apprenticeship Act)
- Vocational school
You cannot use 529 plan funds for:
- Transportation and travel costs, health insurance, extracurricular activities
What if unused 529 plan balances must be withdrawn for non-qualified expenses?
If funds are withdrawn for non-educational purposes, the plan owner will be required to pay taxes on any investment earnings, plus a 10% penalty. Be sure to consult a tax professional for additional guidance.
Is there a limit on how much can be saved in a 529 plan?
In Oregon, the maximum that can be contributed is $400,000 per beneficiary. The balance can grow beyond this amount. Funding limits vary by state; for example, Missouri has the highest contribution limit at $550,000.
Keep in mind, federal gift exclusion limits may apply to funding a 529 plan. For 2022, the federal annual gift exclusion is $16,000 per donor, per beneficiary, without triggering any gift tax. For example, mom and dad are allowed to each contribute $16,000 (a combined $32,000) to one of their child’s 529 plan accounts each year. They can also gift that same amount for each additional child (or any other person) they wish to support. Grandparents can do the same.
The IRS also permits taxpayers to gift 5 years’ worth of the annual gift exclusion ($16,000 x 5 years = $80,000 for single or $160,000 for a couple) and “super fund” an account. This can be a great strategy to pre-fund the majority of, if not all, a child’s college expenses.
How do I spend 529 plan funds?
You can pay the school or university directly, although you should check with the institution to confirm this is an option. Alternatively, you can reimburse yourself from the 529 plan for a payment made directly to the school.
Be sure reimbursement happens in the same year as the expense, and always keep your receipts.
Will investing in a 529 affect my student’s eligibility for financial aid? What if my student gets a scholarship?
529 plan funds are considered assets of the parents/plan owner under the Expected Family Contribution (EFC) section of the Free Application for Federal Student Aid (FAFSA®). As a result, use of 529 plan funds will have a small effect on financial aid eligibility.
If your child is granted a scholarship, you can withdraw the amount of the scholarship award from the 529 plan; however, federal and state taxes on earnings still apply.
I’m a grandparent. Should I set up my own 529 plan for helping my grandkids or contribute to the account their parents set up?
There is a tricky relationship between 529 college savings plans and student aid, assuming your grandchild will need federal aid to help pay for college.
Grandparents who choose to contribute directly to a parent-owned 529 can in some cases receive a state tax deduction or credit. By gifting money to the parent-owned 529, grandparents also benefit in that they do not have to manage an account. More importantly, they can support their grandchild without directly affecting financial aid eligibility.
Grandparents who prefer to open a 529 can control plan distributions, investments, and beneficiaries. They can also reap tax benefits by reducing the size of an estate or receiving a tax credit or deduction (if the plan offers one).
There is one downside to grandparent-owned 529s, however. Currently, the FAFSA requires applicants to report contributions they’ll receive from non-parent sources, which then adds half of that gift amount to the Expected Family Contribution. This impacts a student’s overall federal aid eligibility. However, under new rules which take effect in the 2024-2025 school year, this question will be removed from the simplified FAFSA. As a result, students will no longer be required to report funds from non-parent sources that are later withdrawn.
Can I use my 529 to fund K-12 schooling?
The Tax Cuts and Jobs Act of 2017 resulted in a change to federal taxes that allows 529 plans to be used for K-12 expenses, limited to $10,000 per year per beneficiary. Eligible expenses include tuition for public, private, or religious schools of the beneficiary’s choosing.
In Oregon, however, there are potential state tax implications of these distributions. Taxpayers may need to add back to their taxable income any amount of their K-12 distribution that initially received an Oregon state income tax benefit when the 529 plan was funded.
We recommend consulting your Vista team and/or your tax professional for more information.
A final word: When you’re contemplating the best way to pay for your child or grandchild’s education, your Vista advisor is here to help!
