529 savings plans, named after the section of the Internal Revenue Service (IRS) code that establishes the plans, are one of the nation's most advantageous ways of saving for higher education expenses. These qualified tuition plans allow federal tax-free withdrawal of earnings and possible tax deductions, which can help families afford and pay for the rapidly increasing cost of college.
One of the primary benefits of 529 plans is the large contribution limits. Each state operates its own 529 plan and makes its own rules for the plan, so maximum contribution levels vary across states. Typically, contribution limits are high enough that most investors will never have to worry about hitting the ceiling, but those individuals considering attending a private university or Ivy League school could find themselves needing to save a significant amount of money to pay for college bills.
For the 2018 to 2019 school year, the cost of a year of school at a mid-priced college for an in-state student was approximately $21,370, including tuition, fees, room, and board. For students attending an out-of-state school, the cost rises even further, to $37,430. A year of private school averaged more than twice that at $48,510. Therefore, it’s incumbent on families to try to save as much as possible as early as possible to get ahead of rising education costs.
- 529 plans allow investors to save and grow money on behalf of a beneficiary, such as a child, grandchild, niece, nephew, or even for themselves; the money grows tax-free and can be withdrawn tax-free, provided it is used for educational purposes.
- There are two main types of 529 plans, prepaid tuition plans, in which the plan holder pays in advance for the beneficiary's tuition and fees at a specific school, and savings plans, which are tax-advantaged investment vehicles, similar to IRAs.
- Earnings from a 529 plan are exempt from federal income taxes, so long as they are used for qualified educational expenses including tuition, fees, certain electronics, such as a computer, books and other needed classroom equipment, and room and board.
- Plan distributions that are used to pay for items that are not qualified educational expenses are taxed and subject to a 10% fee, with exceptions made for circumstances such as death and disability.
- Plan contribution limits vary from state-to-state, with Georgia, Mississippi and Tennessee offering the lowest maximum balance, at $235,000, and Pennsylvania, New York and California the highest maximum balance, at over $500,000.
Determining Contribution Limits
To qualify as a 529 plan under federal rules, plan balances cannot exceed the expected cost of a beneficiary's qualified education expenses. The generally accepted guideline is that this limit constitutes five years of tuition, room, and board at the most expensive college in the United States.
This guideline makes investment contribution limits quite large although every state is allowed to individually interpret what five years of qualified education costs means. Therefore, each state has a different contribution limit. Potential contributors should check with the state to determine specific investment maximums.
Although originally structured to fund post-secondary education, 529 plans can now be used to fund private K-12 education, since the passage of the Tax Cuts and Jobs Act.
State-specific Contribution Limits
Every state's 529 plan allows for maximum contributions of at least $235,000 per beneficiary. Georgia, Mississippi, and Tennessee have the lowest maximum balance limits at $235,000, followed by North Dakota with $269,000. On the high end, states such as Idaho, Louisiana, Michigan, New Hampshire, South Carolina, Washington state, and Washington DC have maximum limits of $500,000. Pennsylvania limit is $511,758, New York's limit is $520,000 and California's limit is $529,000. Once this point is reached, any contributions made to the account are not accepted and will be returned to the investor.
These contribution limits apply to each beneficiary. For example, in Georgia, which has a $235,000 maximum contribution limit, a set of parents contributing $200,000 for a beneficiary and a set of grandparents also contributing $200,000 to the same beneficiary would not be allowed.
Contribution maximums generally do not apply across states. An investor hitting the maximum in one state would likely be eligible to contribute further in another state's plan, but individuals should check with plan administrators first to make sure this is allowed.
The number of total assets invested in 529 plans as of 2018, according to the latest information from the College Savings Plan Network.
Gift Tax Considerations
Outside of a 529 plan, contributions of more than $15,000 per year to any individual would trigger the gift tax. But there is an exception made for contributions within a 529 plan. A grandparent could, for example, contribute a $75,000 one-time lump sum contribution to the plan, with the understanding that it would cover five years' worth of gifts. As long as that person doesn't contribute again in the next five years, there is no tax consequence.
Your taxable income is not reduced by contributing to a 529 plan, however, over 30 states give out tax deductions or credits for contributions made to a 529 plan.
Who Can Contribute to a 529 Plan?
Anyone can contribute to a 529 plan account and can name anyone as a beneficiary. Parents, grandparents, aunts, uncles, stepparents, spouses and friends are all allowed to contribute on behalf of a beneficiary. While there are no income restrictions for the contributor, the maximum contribution limit applies to the beneficiary, not the individual making the contribution. Balances designated for a specific beneficiary cannot exceed the maximum allowed by the state's 529 plan.