Start the Year Off Right with a 529 Savings Plan

529s - A Great Way to Save, Even if You Don't Have Kids Yet

Welcome to the first 2020 issue of Saving Money with Andrew!

Most people are familiar with 401(k)s (80 million active participants in the US with $5.7 trillion in assets) and IRAs (46.4 million households in the US with $9.8 trillion in assets).[1] And this is for good reason - for most people able to contribute, the tax benefits of these accounts are very compelling, even if one’s employer does not offer a matching contribution.

Far fewer are familiar with 529 Savings Plans (14 million accounts with $329 billion in assets, including the Obamas, who made a large contribution to their own 529 Plan in 2007). These plans, created by Congress in 1997, allow individuals to save money for their own or others’ education expenses by contributing to a “529 Savings Plan”. These plans offer three great benefits:[1]

• In the majority of states, contributions up to a certain limit are tax-deductible from your state taxes. For example, if you are in New York and are in the 6.33% tax bracket, a $5000 contribution would save you ~$317 on your tax bill

• Investment income in a 529 Savings Plan is not taxable until withdrawal

• Withdrawals from a 529 Savings Plan are tax-free if they are used for qualified education expenses.[2] Non-qualified withdrawals are subject to tax and a 10% penalty (but only on the income, not on the original contribution)

Here’s a helpful table comparing 529 plans to IRAs and 401(k)s:

Essentially, as long as you use the 529 to pay qualified education expenses, it combines the tax benefits of a Roth 401(k) or Roth IRA (tax-free distributions) with an additional upfront bonus of a state tax deduction (in most states).

To get started, find the 529 savings account provider for your state. Make sure to review the fees charged by the plan provider (they often vary significantly from state to state).

These plans are well-worth considering for parents, and there are many others who might find a 529 very interesting as well, including:

• Grandparents who want to save for their grandkids’ educations, while still maintaining control of the account and investments (and getting a tax benefit)

• Singles and childless couples who intend to have kids. In most situations, you can open an account with yourself as beneficiary, and just change it down the road.[3] You could even use the funds for your own educational expenses, or for another relative.

By contrast, 529s make less sense for those who don’t intend to have children, or don’t plan to save for a family member’s educational expenses. Otherwise, 529 accounts are well-worth considering, especially if you are already “maxing out” other retirement accounts. As always, consult your accountant or financial adviser when making a big decision like this.

I hope this has been helpful. If you liked it, please share it with a friend! Also, please send me your feedback, requests, and success stories.

[1] There are other significant potential estate planning benefits, as well as financial aid planning, but those are well beyond the scope of this post.

[2] Including college tuition, of course, but also certain related expenses. Recent changes offer limited ability to use 529 money for K-12 tuition and loan repayment, but these rules are complicated and may vary by state.

[3] Keep in mind that the beneficiary can be changed, but there may be tax issues if the account is large and the new beneficiary is in a different generation from the previous one. Consult your accountant if you’re in this situation.