529 plans and education funding.

• Author: Demosthenes, Alexandra

Funding the higher education of a child or grandchild can be one of the biggest financial accomplishments in someone's life. Helping clients do so thoughtfully and with a plan will ensure that goal is not only attainable but also in line with their expectations. A great way to begin saving for college is to use a qualified tuition program under Sec. 529, more commonly referred to as a 529 plan.

Features and benefits of a 529 plan

A 529 plan is a tax-advantaged plan designed to encourage saving for future education expenses. Individual states sponsor 529 plans, although there are no restrictions against an individual's opening an account in any given state.

Tax advantages to saving for college in a 529 plan--rather than a regular savings or brokerage account--include that earnings grow on a tax-deferred and potentially tax-free basis. That means account owners will not owe taxes on the account's dividends, interest, capital gains, and other appreciation as long as the funds are used for qualified higher education expenses. Qualified higher education expenses include tuition, fees, books, supplies, and room and board (Sec. 529(e)(3); see also Toolson, "The Unique Benefits of 529 College Savings Plans," 54-5 The Tax Adviser 30 (May 2023)).

Contributions to a 529 plan are not tax-deductible at the federal level; however, many states offer tax incentives, such as deductions or credits, for contributions to their specific 529 plans. In most cases, taxpayers must contribute to their home state's 529 plan to qualify for a state income tax benefit. For example, an account owner or beneficiary who files a New York state resident return can claim a state income tax deduction of up to $5,000 for contributions to or withdrawals from a New York 529 plan ($10,000 if married filing joindy). If they are in the 6.85% state income tax bracket and make the full $5,000 contribution, it could be a tax savings of $342.50. However, if the same taxpayer contributed to another state's 529 plan, they would not qualify for the New York state income tax deduction.

A 529 plan allows an individual to open an account on behalf of a designated beneficiary, most often a family member such as a child or grandchild. The account owner retains control over the funds and can make investment decisions within the plan's options. They can also change the beneficiary or take back the funds for nonqualified purposes, although taxes and penalties may apply to nonqualified withdrawals.

Another benefit to 529 plans is that there are no annual contribution limits, unlike Sec. 401 (k) plans and individual retirement accounts (IRAs). However, each state limits...