The 7 key benefits of a 529 plan

When your child goes to college, it’s a huge step for them. But it can also be a huge financial undertaking for you and your child. Student loans and financial aid aren't the only options to pay for college. Have you ever heard of saving early for your child's higher education with a 529 plan?

These plans allow you to put away cash for their college education so you don’t have to worry about rushing to get financing before the school year begins. But how exactly do these plans work, and what are the benefits of a 529 plan? Let’s dig in.

What is a 529 college savings plan?

A 529 college savings plan, legally called a “qualified tuition plan,” is a tax-advantaged plan that helps with saving for college, university, or vocational school costs. These qualified tuition programs, which are sponsored by states, state agencies, or educational institutions, come in two forms: prepaid tuition plans or education savings plans. Let’s dive into what the two plans offer and how they differ.

Prepaid tuition plan

With a prepaid tuition plan, the saver or account holder purchases units or credits from participating schools at the current price for future tuition and fees for the plan beneficiary. The state usually sponsors these plans, so they have in-state residency requirements to be eligible. Keep in mind, prepaid tuition plans can only be used for higher education and can’t be used for K-12 tuition payments. 

These plans are not always guaranteed. If the sponsor — typically the state — has financial issues, there’s no guarantee the beneficiary’s tuition will be paid in full. Check with your state’s plan to find out if it is or is not guaranteed.

Also, if the beneficiary chooses to attend a non-participating school or a school outside their home state, the plan may pay less than if they attended a participating school.

Prepaid tuition plans sometimes have fees, which are generally limited to enrollment or application fees and future administrative fees.

Be a financially smart family!

Be a financially smart family!

From saving for the future to understanding credit, see how families are thriving with Greenlight.

Try Greenlight today

Education savings plan

An education savings plan (ESP) is a brokerage or investment account where the account holder can save for the beneficiary’s future qualified education expenses. 

So, what are “qualified higher-education expenses” exactly? This includes tuition, room and board, mandatory fees, and required books, computers, and software.

You can use withdrawals from these education savings accounts at any college or university nationwide — and even worldwide in some cases. Up to $10,000 annually can even go toward a beneficiary’s K-12 tuition at a public, private, or religious elementary or secondary school. Withdrawals are not limited when the student is in college, as long as they’re for qualified higher-education expenses.

When the saver opens and invests in an ESP, they can choose from various investment options, such as mutual funds or exchange-traded funds (ETFs). You can choose time-based investment plans and portfolios that target the date the beneficiary will need the cash and use historical data to choose investments that will help the account grow to the necessary balance in that time frame.

These plans are always state-sponsored, but only some have strict residency requirements to determine eligibility for the saver or beneficiary. Because this is an investment account, the funds are not guaranteed, and you can lose 100% of your investment.

As an investment account, an ESP may have additional fees on top of the enrollment or application fees. These other fees may include annual account maintenance, ongoing program management, and ongoing asset management fees.

What are the benefits of a 529 plan?

With a general understanding of what a 529 plan is, you’re likely still wondering, “What is the benefit of a 529 education saving plan?” Why not open your own investment account or just take out student loans and other financial aid? 

Let’s review the seven benefits of a 529 plan and see why it may be a great option.

1. Tax-deductible contributions

First, consider the 529 plan tax benefits. While you won’t get a federal income tax deduction, 75 of the nationwide 529 plan providers have state income tax deductions for residents.

The state tax benefits vary based on a range of factors, so check with your state, the individual plan, and a tax advisor for specifics.

2. High contribution limits

Like any IRS-regulated investment plan, 529 plans have contribution limits, but they are very high. These contribution limits range from $269,000 in North Dakota to $569,123 in New Hampshire. Keep in mind, that is the total contribution, not an annual number. But still, if you’re in a state that collects income tax, that gives you a lot of freedom to lower your tax burden annually.

When determining your contributions, keep the gift tax in mind. In 2023, individuals can contribute up to $17,000 and married couples can contribute up to $34,000 to a 529 savings account without incurring this tax.

3. Tax-deferred growth

When you invest in a 529 account, it may grow over time just like any other investment account. Unlike a traditional brokerage account or even an interest-bearing bank account, a 529 plan’s growth is tax-deferred, meaning you won’t pay state or federal income taxes on annual growth.

4. Tax-free withdrawals

When sending your kids (the beneficiaries) to school and using 529 funds to pay for their education, the withdrawals for qualified education expenses don’t count as taxable income. This includes any growth the account had over the years.

Non-qualified withdrawals, however, may be subject to income tax and a 10% penalty.

5. Flexible transferability

What if the beneficiary doesn’t go to college or gets a full scholarship and you have no one to transfer it to and no other qualified educational expenses to spend it on? Fortunately, a 529 plan has options in this case.

One option is to simply cash it out. The account owner can withdraw 100% of the funds from the 529 account and use them as they please. The downside to this is you will pay income tax on all growth plus a 10% penalty.

And thanks to the SECURE Act 2.0, signed in 2022, you will have a new option for your 529 account starting in 2024. At that time, you can transfer the 529 savings funds into a Roth IRA in the beneficiary’s name. There are some stipulations to these rollovers, though:

• The lifetime maximum you can transfer from a 529 account to a Roth IRA is $35,000.

• You must still abide by the annual IRA contribution limits every year.

• The 529 plan must have been open for at least 15 years.

Yet another option is to transfer the 529 account funds to one of the beneficiary’s immediate family members, including:

• Spouse

• Sibling

• Step-sibling

• Parent

• Descendent of either parent

• Step-parent

• Niece or nephew

• Aunt or uncle

• Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law or any of their spouses

• First cousin

6. Spread college tuition over a longer term

There’s no way around it — college is expensive. A 529 plan allows you to spread these costs out from when a child is conceived or adopted until they decide to go to school. This allows you to take on the cost of college over many years instead of condensing it into four years or focusing solely on financial aid.

7. Low maintenance

Enrolling and maintaining a 529 plan is fairly low maintenance. You can generally enroll online with only basic personal information. Then, you set the monthly contributions and remain mostly hands-off from there. 

In education savings plans where you handle investments, you can simply choose the best path for the beneficiary — mutual funds, ETFs, time-based portfolios, and others — and the plan handles all the investment management.

A 529 plan can help prepare for the expense of higher education

You can save toward college for your kids in many ways, including with a 529 plan. Whether it’s the prepaid tuition plan or the education savings plan, both allow you to spread out the higher education costs over many years instead of only four years. Plus, you can enjoy the many other benefits of a 529 plan listed above. But speak with a financial or tax advisor about your specific situation before making any decisions. 

Your child can also help contribute to their college expenses through savings while they’re in school. The Greenlight app can help them learn all about financial literacy and how to save. It also offers 1% Cash Back to Savings and up to 5% Rewards on Savings.* 

Download the Greenlight app today to see what it has to offer.

*Greenlight Core families can earn 2% per annum, Greenlight Max families can earn 3% per annum, and Greenlight Infinity families can earn 5% per annum on an average daily savings balance of up to $5,000 per family. To qualify, the Primary Account must be in Good Standing and have a verified ACH funding account. See Greenlight Terms of Service for details. Subject to change at any time. **Greenlight Max and Infinity families can earn 1% cash back on spending monthly. To qualify, the Primary Account must be in Good Standing and have a verified ACH funding account. See Greenlight Terms of Service for details. Subject to change at any time. ***Requires mobile data or a WiFi connection, and access to sensory and motion data from cell phone to utilize safety features including family location sharing and driving alerts and reports. Messaging and data rates and other terms may apply.