Saving For College With A 529 Plan

Brandon R. Amaral, CFP®, EA
Brandon R. Amaral, CFP®, EA

Founder & Financial Planner, Amaral Financial Planning

So how much does it cost to raise a child? According to U.S. News, the average cost to raise a child to adulthood is $267,233 in 2021. And no, this does not include college expenses.

With inflation on the rise and tuition increasing each year, it can seem impossible to afford college. While taking out student loans is also an option, this could potentially set your child back for many years or leave them with a lifelong payment.

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Here is an overview of 529 Plans:

What is a 529 plan?

A 529 plan is a type of investment account that allows you to save money for college and avoid paying taxes. There are also two types of 529 plans:

  • College savings plans
  • Prepaid tuition plans

With prepaid tuition plans, you are able to lock in today’s tuition costs. Full stop.

For college savings plans, you are able to invest your savings, withdraw the growth tax-free, and use the funds to pay for tuition, room and board, and books.

What are the benefits?

For regular taxable accounts, taxes are pretty straightforward. Any interest or dividends you receive, you will owe taxes on. If you sell any stocks, you will also owe taxes on any gains you realize.

This is not the case for 529 plans. Any income or growth that is generated within the account is tax-free. Additionally, when you withdraw funds from the account, you will not owe any taxes if they are used for qualified education expenses. If you do not have qualified expenses, then you will be subject to ordinary income taxes and a 10% penalty.

What expenses can you use them for?

In order to qualify for tax-free treatment, your withdrawals must be used to pay for qualified education expenses. These expenses include:

  • Tuition and fees
  • Books and supplies
  • Room and board
  • Computers or software

Certain expenses that are not eligible include:

  • Travel expenses (flights or gas)
  • Fraternity dues
  • College application fees
  • Health insurance

While 529 plans are primarily used for college, you are also eligible to use up to $10,000 per year to pay for tuition at K-12 schools.

How much can you contribute?

Unlike other tax-advantaged accounts, 529 plans do not have annual contribution limits. However, a common funding consideration is the federal gift tax exemption limit.

Each year, the IRS sets an annual gift limit that is not subject to the Federal gift tax. For 2022, this amount is $16,000 per donor, per beneficiary. This means that a married couple could contribute $32,000 in a single year to their child’s 529 plan without triggering any gift tax. For families who have the financial means, there is also an option to “front-load” 529 plans by making 5-year’s worth of contributions at once.

529 plans are great investment vehicles to save for college and reduce your tax bill. If you would like to work with a financial planner to walk you through your options, I would love to help you!

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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.