Education Planning with a 529
Planning for your child's education expenses can seem daunting, but 529 plans offer a structured and tax-advantaged way to save for their future. In this blog post, we'll explore the ins and outs of 529 plans, including who can open them, who the beneficiaries can be, contribution limits, penalties for withdrawals, tips on choosing the best plan for your needs, and a brief history of 529 plans and college savings vehicles, with a special focus on Minnesota's 529 plan. We’ll also look at the projected increase in college costs and how that impacts your savings strategy.
Understanding 529 Plans
What is a 529 Plan? A 529 plan is a tax-advantaged savings account designed to encourage saving for future education costs. Named after Section 529 of the Internal Revenue Code, these plans are administered by states or educational institutions and offer a range of benefits for families planning for college and other educational expenses.
A Brief History of 529 Plans
The Evolution of College Savings Vehicles - Before the establishment of 529 plans, families often used traditional savings accounts, bonds, or trust funds to save for college expenses. While useful, these methods lacked the tax advantages specifically tailored for educational savings. In 1986, the state of Michigan pioneered a new concept with the Michigan Education Trust (MET), a prepaid tuition program that allowed families to lock in tuition rates at current prices.1
The Birth of 529 Plans - The success of prepaid tuition programs like MET highlighted the need for more flexible and tax-advantaged savings vehicles. In 1996, Congress passed the Small Business Job Protection Act, which included the creation of Section 529 of the Internal Revenue Code, formally establishing 529 plans. These plans were designed to offer tax benefits similar to retirement accounts but specifically for education savings1.
Who Can Open a 529 Plan and Who Can Be a Beneficiary?
Account Owners: Anyone can open and contribute to a 529 plan—parents, grandparents, other relatives, or even friends. The person who opens the account is usually the account owner and controls the account, making decisions about withdrawals and investments. In contrast, a minor savings account is typically opened by a parent or guardian who also controls the account, but the funds legally belong to the minor once they reach the age of majority. This means that the child gains full control over the funds and can use them for any purpose, not necessarily education-related expenses.
Beneficiaries: The beneficiary of a 529 plan can be anyone—your child, grandchild, or even yourself if you plan to go back to school. The account owner has the flexibility to change the beneficiary to another qualifying family member if needed. Qualifying family members include siblings, step-siblings, parents, stepparents, children, grandchildren, nieces, nephews, aunts, uncles, and in-laws.
Future Children or Grandchildren: You can open a 529 plan even if your intended beneficiary hasn’t been born yet. To do this, you can name yourself as the beneficiary and then change the beneficiary designation to your future child or grandchild once they are born.
Contribution Limits
Annual Contributions - There is no federal annual contribution limit for 529 plans. However, contributions are considered gifts for tax purposes, and the annual gift tax exclusion amount is $18,000 per donor, per beneficiary in 20242. This means each parent can contribute up to $18,000 per year per child without incurring gift tax.
Lifetime Limits - Each state sets its own lifetime contribution limits for 529 plans, typically ranging from $235,000 to $550,000 per beneficiary. For the Minnesota College Savings Plan, as of 2024, the maximum contribution limit is $425,000 per beneficiary across accounts3.
Penalties for Withdrawals
Qualified Withdrawals: Withdrawals from a 529 plan are tax-free when used for qualified education expenses. These expenses include tuition, fees, books, supplies, and equipment required to enroll or attend an eligible educational institution. An eligible educational institution includes most accredited postsecondary institutions, such as colleges, universities, vocational schools, and other postsecondary institutions eligible to participate in federal student aid programs. This can also include certain foreign institutions. Additionally, room and board are covered if the beneficiary is enrolled at least half-time.
In recent years, the definition of eligible educational institutions has expanded to include private elementary and high schools. Thanks to the Tax Cuts and Jobs Act of 2017, up to $10,000 per year per beneficiary can be used from a 529 plan to pay for tuition at K-12 private schools, providing families with more flexibility in managing education expenses from kindergarten through higher education2. However, it’s important to note that not all states conform to this federal provision, so it’s crucial to check your state’s specific rules regarding K-12 tuition coverage.
Non-Qualified Withdrawals: If you withdraw funds for non-qualified expenses, the earnings portion of the withdrawal will be subject to federal income tax and a 10% penalty. The principal contributions are not subject to tax or penalty since they were made with after-tax dollars. Exceptions to the penalty include situations where the beneficiary receives a scholarship, attends a U.S. Military Academy, dies, or becomes disabled.
Spotlight: The Minnesota 529 Plan
The Minnesota College Savings Plan is the state's 529 plan, designed to help families save for future education expenses with tax advantages.
Tax Benefits for Minnesota Residents
Minnesota offers state tax benefits to residents who contribute to the Minnesota College Savings Plan:
State Income Tax Deduction: Up to $1,500 for single filers and $3,000 for joint filers can be deducted from state taxable income3.
State Income Tax Credit: Alternatively, families may qualify for a state income tax credit of up to $500, depending on their income level3.
Fees and Investment Options - The Minnesota College Savings Plan offers a variety of investment options managed by TIAA-CREF, including age-based portfolios that automatically adjust the asset allocation as the beneficiary approaches college age, and static portfolios that maintain a fixed asset allocation. The plan is known for its low fees, which may help maximize your returns3.
Portability and Flexibility - Funds in the Minnesota College Savings Plan can be used at any eligible educational institution nationwide, including two-year colleges, four-year universities, graduate schools, K-12 private schools, and trade schools. Additionally, if you move out of Minnesota, you can still keep and use the plan without losing any benefit3.
How to Choose the Right 529 Plan
State Tax Benefits - When choosing a 529 plan, consider whether your state offers tax benefits for contributions. Minnesota's tax deductions and credits can provide significant savings.
Fees and Investment Options - Compare plans based on their fees and investment options. Some plans have higher fees than others, which can eat into your savings over time. Look for a plan with low fees and a range of investment options that suit your risk tolerance and investment style.
Portability - Remember that you are not limited to your state's 529 plan. You can invest in any state's plan, and your beneficiary can use the funds to attend eligible institutions in any state. However, if your state offers significant tax benefits, it may make sense to use your home state's plan.
Performance and Management - Research the performance and management of the plan's investment options. Look at historical performance, the reputation of the plan manager, and the variety of investment portfolios available. Some states offer plans managed by well-known financial institutions with strong track records.
Projected Increase in College Costs - The cost of college education has been steadily increasing over the past few decades. According to the College Board, the average annual increase in tuition and fees over the last decade has been about 3% to 4% at both public and private institutions1. Projections indicate that this trend is likely to continue. For instance, if the current average annual cost of a private four-year college is approximately $53,000, it could rise to about $82,000 per year by 2033, considering a 4% annual increase1.
To illustrate the importance of starting early, let's consider a baby born in 2024. Assuming a 4% annual increase in college costs, the projected average annual cost of a private four-year college by the time this baby begins college in 2042 would be approximately $120,000 per year. Over four years, this totals about $480,000.
If parents start saving immediately and aim to cover this future cost, they would need to consider the power of compound interest. Assuming they can achieve an average annual return of 7% on their investments, they would need to save approximately $620 per month from the time the child is born to accumulate enough to cover the projected costs.
Conclusion
A 529 plan is a powerful tool for planning your child's education expenses. By understanding who can use these plans, how much can be contributed, and the rules around withdrawals, you can make informed decisions that will benefit your child's future. Minnesota's 529 plan offers excellent tax benefits and flexible investment options that may help you maximize your savings.
At Fortress Financial Group, we are committed to helping educate you on navigating the complexities of saving for your child’s education. Contact us today to learn more about how we can assist you.
References:
College Board. (2023). Trends in College Pricing and Student Aid 2023.
IRS. (2024). Publication 970: Tax Benefits for Education.
Minnesota College Savings Plan. (2024).
Disclosures:
All investing involves risk, including loss of principal. No strategy assures success or protects against loss.
Fortress Financial Group LLC (“FFG") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where FFG and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at https://fortressfg.net/. For current FFG information, please visit the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with FFG’s CRD# 315329.
Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
