What Can You Do With a 529 Plan Account?

Are you saving for college in a 529 plan account and want to know what you can use the money for? Whether you’re saving for yourself or a beneficiary, you’ve come to the right place. This guide discusses 529 plan accounts, considering qualified higher education expenses and non-qualified withdrawals. You’ll also learn about the alternative uses and the tax benefits of such accounts. 

What Is a 529 Plan Account? 

A 529 plan account is an investment designed to encourage savings for future education expenses. It is tax-advantaged and authorized by section 529 of the Internal Revenue Code. State agencies and educational institutions sponsor these investment accounts. There are two primary types of 529 plan accounts:

• Prepaid tuition plans: These allow you to pay tuition and fees to designated colleges and universities in advance. Although generally designed for in-state public education, they can sometimes be converted for use in private and out-of-state institutions. The payment could be partial or complete, depending on financial strength and preference. 
• Educational savings plans: These investment accounts allow you to save towards qualified higher education expenses, including tuition, books, and room and board. Account holders can choose a preferred investment type, which determines how much the account grows over time. You can use the funds at any eligible educational institution in the United States.

529 Plan Account Rules

Here are the general 529 plan account rules:

1. You may invest in a different state’s 529 plan account, but most states offer residents tax deductions.
2. The account holder, not the beneficiary, controls the funds.
3. There are strict rules regarding fund distribution and usage.

What Are the Investment Options Available Within 529 Plan Accounts?

The investment options available within 529 plan accounts include the following:

• Mutual funds: These are pools of funds from investors invested in stocks, bonds, securities, and money market instruments. A professional funds manager manages the diversified portfolio and shares the profit and loss in the portion of the investments. 
• Exchange-traded funds (ETFs): Like mutual funds, ETFs are professionally managed collections of individual stocks or bonds. However, they differ in how they are priced, purchased, and sold. Generally, mutual funds are bought and sold at the end of the trading day, while ETFs are traded on stock exchanges throughout the trading day.
• Age-based portfolios: Also known as target date funds, these are designed to align with the investor’s retirement time horizon by automatically adjusting its asset allocation, becoming conservative as the target date approaches. They typically rebalance their holdings to reduce risks as the investors get older.

What Does a 529 Plan Account Cover?

529 plan accounts cover the following:

• Tuition: You can use the funds from a 529 plan account to pay for tuition at eligible colleges, universities, and vocational schools. You may also use it to cover K-12 expenses, up to $10,000 per year.
• Room and board: You can use the funds to cover expenses for room and board for students enrolled at least half-time.
• Books and supplies: You can use the funds to purchase books, supplies, and equipment for education.
• Computers and software: You can use the funds to purchase computers, accessories, and software for education. The funds may also cover internet and other related expenses. 
• Special needs services: Students requiring special needs services can use funds from 529 plan accounts to cover those costs.
• Student loan payments: You can use up to $10,000 from a 529 Plan Account to repay qualified student loans.

The non-qualified expenses include the following:

1. College application and entrance fees
2. Clubs and activities fees
3. Sorority and fraternity dues
4. School-sponsored health insurance
5. Other living expenses

Non-qualified withdrawals incur taxes and a 10% penalty.

What Are the Alternatives Uses of 529 Plan Accounts? 

If the beneficiary (student) receives scholarships or grants, resulting in more money in the 529 plan account than needed, the account holder can change the beneficiary. If the student receives scholarships, there is an opportunity to remove the matching funds from the 529 plan account penalty-free, but the beneficiary will still be subject to income tax on the earnings. The student may also use the funds to cover other educational expenses beyond what they intended, such as graduate or professional programs. You may also roll over the 529 plan account assets to a Roth IRA, subject to specified limitations.

Other alternative uses of 529 plan accounts include the following:

1. Accredited trade and vocational schools 
2. Accredited apprenticeship programs
3. Accredited international institutions

What Are the Tax Advantages of Investing in 529 Plan Accounts?

529 plan accounts offer federal tax benefits. Depending on where the account holder or contributor lives, they may also provide state tax benefits.

Federal Tax Benefits

The two primary tax benefits associated with 529 plan accounts are:

• Tax-deferred growth: Earnings in the 529 plan account grow tax-free. Income taxes are deferred as long as the money stays in the account.
• Tax-free withdrawals for 529 qualified expenses: The account holder does not pay federal income taxes on withdrawals for qualified education expenses. Most states also exempt these withdrawals from state income taxes. Any other withdrawals are usually subject to taxes and penalties, with certain exceptions like death or disability.

State Tax Benefits

Depending on their residence, account holders or contributors may also qualify for state tax benefits. Many states offer tax credits or income tax deductions for 529 plan account contributions.

Estate Planning Benefits

Depending on the state and how the investment is structured, 529 plan accounts may also have estate planning implications. Generally, assets in the account are exempt from federal estate taxes. Federal tax law treats the contributions as completed gifts and removes them from the donor’s estate. Again, contributions up to a specified amount qualify for annual gift tax exclusions. They are not counted against the donor’s lifetime gifts or estate tax exemption.

Some states impose additional estate and inheritance taxes, subject to legal exceptions. For example, inheritance taxes are inapplicable in many states if the assets are inherited by a lineal descendent, such as children and grandchildren. Inheritances to heirs like siblings, uncles, or aunts will usually incur inheritance taxes. Although spouses are not lineal descendants, most states provide notable exceptions. Only a few states still impose inheritance tax on surviving spouses.

State estate taxes usually depend on the estate’s value — assets below the specified threshold are excluded from estate taxes. In most states, 529 plan account contributions are exempt from estate taxes, with certain exceptions.

What Are the Downsides of 529 Plan Accounts?

First, non-qualified withdrawals incur taxes and penalties. However, account holders may keep the money in the account and use it to cover other qualified expenses than what they initially intended. Second, investing in a 529 plan account can impact your financial aid eligibility, although that is not definite. Account owners also have limited control over how the money is invested since a fund manager runs most options.

How HSC Wealth Advisors Can Help With Your College Savings Strategy

Do you need help creating or managing a college savings account? HSC Wealth Advisors is ready to help. We have years of experience in education investment planning with professionals providing services to clients in Virginia and beyond. Our personalized solutions allow us to develop investment strategies tailored to your needs. Contact us today to learn more!