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The 10 Most Important Questions for your 529 Plan

Updated: Feb 2, 2022

529 investment planning
Before you open a 529 plan, consider our TOP 10 questions

Paying for education – be it elementary, high school, or university – can be an overwhelming challenge for most parents (and students) due to the astronomical costs of tuition, plus the high rate of “education inflation”.

Section 529 college savings plans are US-based, state-administered education investment programs that are authorized under Internal Revenue Code Section 529 (thus the nickname “529s”). Although they are not your only option to save for education expenses, many consider them the best vehicles to meet all kinds of education-financing goals.

As you begin your journey to invest in your kids’ education or your own development, here are our answers to what we consider to be the 10 most important questions for 529 plans.

1. Is there a tax benefit?

Certainly. In fact, lower taxes are one of the main reasons why these plans are so popular. 529 plans allow participants to invest money in an account where the earnings are exempt from federal income tax. After some time, if you use the funds in your account to pay for “qualified” education expenses (e.g. tuition, books, equipment, room & board, etc.) withdrawals will be tax-free.

Your tax benefits are generally maximized if you select a plan offered by the state where you live. Some states offer special state incentives that go above and beyond the usual state tax deductions and tax credits for their own residents. These may include matching grants and even scholarships.

2. Who runs the “show”?

Whoever opens the account is usually the “owner” of the assets, and has full discretion over designating beneficiaries and determining how the funds in the account are invested. However, the rules & limitations of your specific plan will usually be determined by a state agency in conjunction with a program manager.

For example, in the state of New York, the state agencies running 529 plans are the Office of the State Comptroller and the New York State Higher Education Services Corporation. The program manager is Ascensus College Savings. Meanwhile, in Texas, the state agency in charge is the Texas Prepaid Higher Education Tuition Board, with Orion Advisor Solutions acting as the program manager.

Here is a list of the program managers in some of the biggest states:

· Florida – Florida Prepaid College Board

· California, Georgia, Michigan, Wisconsin – TIAA-CREF

· New Jersey – Franklin Distributors

· Pennsylvania, Indiana, Colorado – Ascensus

· Illinois, Alabama – Union Bank & Trust Company

· Ohio – Ohio Tuition Trust Authority

· North Carolina – College Foundation

· Virginia – Virginia529 Board

· Massachusetts, Arizona – Fidelity Investments

· Maryland – T. Rowe Price

· Tennessee – State of Tennessee Department of Treasury

In addition to program managers, keep in mind that many states also partner with an investment manager to act as “program distributor” and help that state develop investment portfolios that will help plan participants meet their education planning needs. Each state and its designated investment manager offer multiple savings options for the investor to choose from.

The investment managers tend to be well-established and nationally-recognized institutions which you might already know. For example, in the states of New York, California and Texas the investment managers acting as program distributors are Vanguard, TIAA-CREF, and Northern Lights, respectively.

3. Who can open a 529 plan, and who is eligible to be a beneficiary?

Any US citizen or resident alien with a Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN) can open a 529 plan. Non-U.S. citizens living outside the US (e.g. grandparents and other relatives) cannot open a 529, but they may still contribute to a child’s 529 plan, as long as it’ owned by someone else.

529 plan beneficiaries must be US citizens or resident aliens with a SSN or ITIN. Pretty much anyone can be named as a beneficiary, regardless of their relationship to the account owner. Common beneficiaries usually include your child or grandchild, but you could also name your niece or nephew, a friend, or even yourself as the beneficiary.

4. What can I invest in?

Most plans give you the option to choose between “age-based” portfolios or individual portfolios. The portfolio mix of “age-based” strategies is determined by the age of the beneficiary. As the beneficiary gets older and approaches the date of the first withdrawal, the investment portfolio will automatically shift to a more conservative strategy.

With individual portfolios, the account owner has more control to design and manage her/his own investment strategy. Some of the options available include a variety of equity funds, fixed income funds, and blended funds. Some states even offer guaranteed or principal-protected options.

5. How often can I change my investment options?

You have the freedom to transfer all or part of your funds from one strategy to another investment strategy, but this can only be done two times per calendar year. One exception to this limitation is when you change the beneficiary of the plan.

When you’re making new contributions to a plan, you can also select a different investment option for that particular contribution, with each new contribution.

6. Which state offers the best 529 plan?

The 529 landscape can be quite competitive (between states). In a sense, each state is not only trying to attract the savings of their own residents, but also those of out-of-state residents. 529 plans have common denominators (e.g. investments for “qualified” education expenses, and tax deductibility), but each plan can also have its own unique pros and cons. In that sense, there is no such thing as “Best 529 Plan”. Before you make your final selection, make sure to weigh the pros and cons of each plan in your shortlist. In the end, the best 529 plan is the one that will make the most sense for you.

Look for programs that offer flexibility, attractive investments, low fees, and generous economic benefits (e.g. state tax incentives). When it comes to state tax deductions, for instance, contributions of up to $10,000 per year by a married couple to a New York 529 plan are deductible from New York taxable income. In contrast, Ohio offers state tax deductions of only up to $4,000 per beneficiary (per year). In New Jersey, only NJ taxpayers with gross income of $200,000 or less qualify for a state income tax deduction of up to $10,000 per taxpayer (per year).

Some states go as far as offering varying degrees of tax credits. For example, the state of Indiana allows you to claim a 20% tax credit against Indiana income tax (up to $5,000 per year) in contributions to their state’s 529 plan. In Vermont that type of credit is only 10% for Vermont income tax.

Then there’s states like California, North Carolina and Hawaii which offer no state tax deductions at all for their 529 plans.

Another factor to consider are maximum contributions. If you think your beneficiaries could use their 529 for multiple education levels (i.e. private high school, university, and Master’s programs), make sure the maximum contribution allowed by your program is sufficiently high to meet your beneficiaries’ needs. In the state of New York maximum 529 plan contributions are currently $520,000, while in Georgia and Connecticut they’re only $235,000 and $300,000, respectively.

Finally, don’t ignore some of the special perks offered by states for local residents. New Jersey offers its plan’s beneficiaries a one-time scholarship of up to $3,000 for one semester at any New Jersey university. In Tennessee, eligible families receive a matching contribution of $100 for a minimum $25 investment, or $500 for a minimum $125 investment. California offers a dollar-for-dollar match contribution of up to $200 on new accounts. The state of Nevada even has a USAA Distinguished Valor Matching Grant Program which matches up to a lifetime maximum of $1,500 of contributions for account owners currently on active duty in the US military and with a household AGI of less than $95,000.

7. Who can contribute to the account?

All 529 plans accept third-party contributions, regardless of who owns the account. Multiple people can make contributions to a single 529 plan, and they don’t need to be related (family) to the beneficiary. Although almost anyone (e.g. grandparents, aunts & uncles, godparents, or family friends) can make contributions, not everyone is guaranteed the tax benefits or perks offered by the plan. That mostly depends on the state where the person making the contribution lives or generates income.

Non-U.S. citizens living outside the US cannot open a 529, but they may still contribute to a child’s 529 plan, as long as it’s owned by someone else.

8. What if my beneficiary decides not to go to college?

The two most important things to do are avoiding rushing into a withdrawal decision, and thinking-through all of your options. Keep in mind that a 529 plan is NOT only a university or higher education plan, but rather a comprehensive “education investment” plan that you can use for all kinds of schooling. For instance, you’re allowed to use up to $10,000 per year on K-12 tuition expenses. That means that, if you suspect early-on that your child will not attend university, you can reduce the risk of overfunding your 529 account by making withdrawals earlier during her or his educational life.

If your beneficiary ultimately does not attend university, there are also plenty of vocational and trade schools (e.g. technical college, culinary school, cosmetology schools, and sports academies) that qualify for 529 withdrawals.

Yet another alternative is to transfer the funds in your 529 plan to a family member of the beneficiary. You can choose an older family member (e.g. parents, grandparents, uncles, step-relatives, in-laws) or younger ones (brothers, sisters, cousins, etc.). You’re allowed to do this type of transfer once per year, with no consequences.

9. Can the plan be used for a semester abroad?

Yes. As long as the study-abroad program your select is sponsored by your U.S. university, it can qualify for 529 withdrawals. If your beneficiary has a strong international orientation and decides to skip education in the US altogether, she/he can enroll in a foreign college or university in which related education expenses may also be covered using a 529 plan. You can learn more about foreign education institutions that are eligible for semesters abroad and full degrees in this U.S. Department of Education student aid site. For a full search of global universities that qualify, use this Federal School Code site, and make sure to select “FOREIGN COUNTRY” under “STATE”.

10. What expenses are NOT considered qualified education expenses?

There’s plenty of items that qualify as 529 educational expenses. However, you might be surprised to learn about some of the items that are NOT qualified. Some of the most common expenses that do not qualify for 529 plans include: testing fees, admission fees, medical bills and healthcare insurance, transportation costs, as well as some clubs and extracurricular activities.

Be aware that if you pay for these type of expenses using your 529 plan, you will be subject to a 10% penalty on the earnings portion. You will also need to repay the income tax and state tax deductions that were claimed. Not a pleasant experience for sure, but it can definitely be avoided if you proceed with care and are mindful of the limits of your 529 plan.

Next steps…

You can continue your 529 journey by learning more about the 529 plan offered in the state where you live. States have their own webpages and hotlines for you to reach out and find out specific information about their plans. You can also rely on online tools to compare 529 plans in different states.

If you’re looking for professional help, a financial planner can help you evaluate the most attractive 529 plans, and ultimately select one that’s most suitable for your household, based on your risk profile, financial situation and educational goals. When seeking help from a financial planner for education plans, it’s extremely valuable if she/he is a “fiduciary” whose interests are fully aligned with yours, and is not incentivized by commissions that could result from recommending specific plans to you.

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