The Origin on 529s

The origin story of the 529 program goes back to the Michigan Education Trust (MET) in 1986. A state-run program that supported colleges saving devoid of state income taxation.  529 plans are named after Section 529 of the Internal Revenue Code (IRC), which was added in 1996 to authorize tax-free status for ‘qualified’ tuition programs. 

The key reason savers enjoy the strategy is that earnings in 529 plans accumulate on a tax-deferred basis. Additionally, distributions are not taxed federally when the funds are applied to higher education and other associated expenses. The definition of other associated expenses is continuing to broaden. In 2015, it was expanded to include computers, in 2017, it included up to $10,000 annually in K-12 tuition, and in 2019 to include student loan payments up to $10,000 (over a lifetime) and costs of apprenticeship programs.

Can a 529 plan be used at any college?

You can invest in almost any state 529 plan, not just your own state’s 529 plan. This is an important discussion to have with your financial planner because while using your own state may make the most sense, there are important tax and investment considerations you should be made aware of. 529 plans can be used to pay for college costs and private schooling at any qualified school and several trade-school programs. Your choice of college is not limited by the state that sponsored your 529 college savings plan. 

You can be a Colorado resident, use the Nebraska 529, and send your student to college in New Hampshire. On our last count, there are more than 6,200 U.S. colleges and universities and more than 400 foreign colleges and universities that easily allow the use of 529s. 

Which states offer 529 plans?

It’s up to each state to decide whether it will offer a 529 plan and what the taxation and limitations for savers might be. It is also up to the state to vet and sponsor the provider of that plan in a state. So 529 plans can offer wide changes from state to state, and there are strategies that might suit your InSight-Full® plan the best. You should understand the features and benefits of your plan before you invest and work with your CFP® to make sure you are getting the most out of the investments you are making.

State and Federal Tax benefits

The good news on taxation however is that there are only a few basic requirements to meet for the federal tax law, and some states offer state income tax incentives to investors as well.  A few states, including Colorado, offer state income tax credits for contributions to the state’s 529 plan. Research your state’s treatment of the 529 and how best to pair it with your overall financial plan. 

What can a 529 plan be used for?

The most obvious application for these funds is for tuition and fees. But the program is actually far more attuned to the real costs of attending college. Books, supplies, equipment, computers, and sometimes room and board are also part of the expenses that can be covered. So the program becomes very flexible as the college picture starts to firm up. If your student gets a large scholarship, but it doesn’t cover room and board off-campus, the 529 might be able to step in and support that college experience. If everything is covered by sports, activities, academics, or work-study, then more can be left for the masters or doctoral program after a 4-year degree. 

The IRS also allows tax-free withdrawals of up to $10,000 per year, per beneficiary to pay for tuition expenses at private, public, and religious K-12 schools. This caveat allows parents and grandparents access to the tax benefits without needing to put money into investments for children that attend schools with tuition. You can simply use the 529 as a pass-through to capture the tax benefits then make the tuition payments accordingly. 

Additionally, tax-free distributions may be used to repay federal and private student loans up to a certain limit. 

How do I use my 529 plan?

Using the distribution can be very open, or part of a rigid plan. Once you and the student are ready to start taking withdrawals from a 529 plan, most plans allow you to distribute the payments directly to the account holder. So the student can be reimbursed with a check personally, or more likely can have a distribution sent directly to the school. There is even a growing number of plants that support payments directly from your 529 accounts to another third party, such as a landlord. 

Read “using my 529 the right way” and “529: 102” to learn more. Remember, you will want to coordinate your distributions with your InSight-Full® plan, your CFP®, and your investment advisor to get the most out of your strategy. You will want to keep accurate records of your expenses, and will more than likely want to report contributions to or withdrawals from your 529 plan on your annual tax returns.