With $7,760 of investment income and tax benefits over the years, you can believe a 529 plan is one of my favorite investment accounts.
I first learned about it while working as a tax intern at a CPA firm. One of the tax managers told me to open an account to pay for my master’s degree because it would save me hundreds a year in state taxes. But it has helped my family in so many more ways:
- My kids have received over $3,000 worth of scholarships through the Colorado Matching Fund.
- We have made over $2,400 of investment income that grew tax-free. This means we saved about $360 in federal taxes.
- We reduced our Colorado state taxes by over $2,000 by contributing to this account.
Many people are afraid to invest in a 529 account because of its myths. I want to debunk all these myths so you can determine if it’s right for you and your family members.
Myth one: “It’s a college fund for kids.”
A 529 account is an education savings plan where the investment income grows tax-free for qualified expenses, and many people assume it is only for kids. However, adults attending higher education can open one to get the tax advantages. There are no age restrictions for having this account.
Thirty states offer state income tax deductions for adding money to the plan each year. If you live in one of these states and are attending school as an adult, it might be beneficial for you to open a 529 account for yourself.
I opened a 529 plan while working on my master’s degree. I would determine the cost of my courses for the semester and add the exact balance to my 529 accounts a month before classes started. Then, I would have the money sent directly to my university to pay for my classes.
I had to hold the money for at least two weeks in the account, and it could take up to two weeks to process the payment for the plan I had. So make sure you know the timeline policy for your account to ensure you are following the procedure and making your payments on time.
Even with the money sitting there for a short period, I made investment income. The best part, it wasn’t taxed at the federal or state level.
It’s never too late to open this account to take advantage of the tax benefits. Even if it’s your last semester in college or if your kid is about to start. You can take advantage of the tax-free income and reduce your state taxes.
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Myth two: “It can only be used for tuition expenses.”
The 529 plan isn’t limited to paying tuition for education. The plan could use for all necessary expenses for education. Here are some are few examples:
- Books and supplies
- Computer and equipment
- Room and board
- Food directly from the school
- Off-campus housing students who are on at least a half-time basis
It includes a majority of costs related to higher education. So if you have saved more than you anticipated, you can use the money towards these costs.
Myth three: “It can only be used at traditional colleges.”
The 529 plan isn’t limited to higher education such as colleges or universities. The plan can use for trade school, vocational programs, and associate degrees. Here are a few examples:
- Cosmetology
- Radiology
- Real estate agent
- HVAC
- Electrician
- Culinary
Just make sure the school you attend is Title IV federal student aid eligibility to use the funds penalty-free.
Myth four: “I can only use it for the person I opened it for.”
The 529 account doesn’t have to be used by the account holder or beneficiary. You can transfer it to an eligible member of your family or roll it over to another account. A transfer to eligible family members is not a distribution, so there are no income taxes. Here are some eligible family members:
- Children
- Stepparents
- In-laws
- Aunts and uncles
- Nieces and nephew
- Cousins of the member
- Spouse’s family.
There is no time limit on the savings plan, so you can keep it until you determine which family can use it. However, there are some rules around the income-tax-free rollover. There is only one tax-free transfer per 12-month period.
Myth five: “I pay the penalty if my child gets a scholarship?”
You can pull the money out penalty-free if your child receives a scholarship or attends a U.S. Military Academy. You will need to pay ordinary taxes on the earnings, though. But that would be the same situation if you were to save or invest your money elsewhere.
If you pull it out for non-qualified expenses, there is a 10% penalty on the earnings. However, the money you can put in is never taxed or penalized because it’s after-tax money you contributed. One of the exceptions to this rule is if your child gets a scholarship. The amount is limited to the amount received in scholarships.
Is a 529 plan right for me?
Overall, a 529 is beneficial for saving money on your state taxes and earning tax-free investment income for education-related expenses.
If you are unsure what education expenses will be in your future, you don’t have to decide now. You can open the account to take advantage of the tax benefits as soon as you are confident the expenses are coming. I waited until my master’s degree to open one for myself and put the exact amount for the related costs to avoid the 10% penalty.
Since it covers a wide range of education expenses and can be transferred to eligible family members, it is an excellent account to contribute to slowly.
Even though my tax internship ended years ago, the 529 plan still benefits my family today.