August has a way of sneaking up on us. One minute it’s summertime, the next it’s school supply lists, new routines, and a reminder of just how quickly children grow up. While most of the focus this time of year is on getting ready for the next grade, it’s also a great opportunity to think a little further ahead, because preparing for education is more than just the year in front of you. With back-to-school season top of mind, I want to share a planning tool that can help prepare for those future costs: the 529 plan.
A 529 plan is a tax-advantaged savings account designed to help pay for education expenses. Contributions are made with after-tax dollars; the funds can then be invested, and the investment can grow tax-deferred over time. When used for qualified education expenses, withdrawals from the account are tax-free.
If funds are taken out and not used for qualified expenses, the earnings portion is subject to ordinary income tax and a 10% penalty. It’s important to note that your original contributions are not taxed or penalized, only the growth is. When used as intended, a 529 plan can be an efficient way to save for education. If funds are not used for education, there can be costly penalties and taxes.
When 529 plans were first introduced, the list of qualified education expenses was more limited. Over time, that list has expanded, making these accounts more flexible than many people realize.
Today, funds can be used for more than just college tuition. Qualified expenses may include tuition, room and board, books, supplies, and required equipment. In addition, certain trade schools, vocational programs, apprenticeship programs, and even a limited amount of K–12 tuition may qualify. It’s always a good idea to confirm specific expenses with a tax professional, but overall, the broader definition of education expenses has made 529 plans a more versatile planning tool.
So what motivates parents to use a 529 plan? There are a few key reasons it can be a valuable tool when saving for education. One of the biggest advantages is the potential for tax-free growth. By avoiding taxes on investment gains, more of that money can go toward future education expenses. Depending on your state, there may also be state tax deductions or credits for contributions.
529 plans also offer flexibility. Funds can be used at a wide range of schools and programs; they’re not tied to just one university. And because the account owner maintains control, there are options if plans change or if all the funds aren’t used. From a planning standpoint, a 529 plan creates a dedicated place to save for a long-term goal, education. Starting early, even with smaller contributions, gives those funds time to benefit from compounding, which can make a meaningful difference over time. And makes saving for a large expense more manageable.
Another important note: most people choose to invest the money within a 529 plan rather than leave it sitting in cash. Your comfort with risk, your timeline, and the purpose of the funds should help guide how the money is invested. If contributions are made but not invested, the funds typically remain in cash and won’t have the same opportunity to grow over time, even with the tax advantages of the account.
A 529 plan has two key roles: the account owner and the beneficiary. The account owner is responsible for managing the account, while the beneficiary is the individual the funds are intended to support. Once the account is set up, contributions aren’t limited to just one person. Parents, grandparents, aunts, uncles, and even family friends can all contribute. In many cases, it can be a meaningful alternative to traditional birthday or holiday gifts, helping put money toward a child’s future education instead.
What happens if the money isn’t used for education? This is one of the most common concerns people have with 529 plans. If funds are withdrawn and not used for qualified education expenses, the earnings portion is subject to ordinary income tax and a 10% penalty. However, your original contributions are not taxed or penalized, only the growth is affected.
If your child receives a scholarship, chooses a different path, or the account ends up overfunded, there are several strategies that can help avoid or reduce penalties. One option is to change the beneficiary. If you have multiple children, the account can be transferred to another child or even kept and used later for a future grandchild. If a scholarship is received, you’re allowed to withdraw funds up to the amount of the scholarship without the 10% penalty. You would still owe income taxes on the earnings portion, but the penalty is waived.
With the expanded definition of qualified education expenses, the funds also don’t have to be used strictly for a traditional college path. They can be used for certain trade schools, vocational programs, and apprenticeship programs. More recently, another option has been introduced: up to $35,000 from a 529 plan may be rolled into a Roth IRA, subject to certain conditions. These include having earned income and staying within annual contribution limits.
Back-to-school season isn’t just about supplies and new routines, it’s also an opportunity to think about the future. With education top of mind, it may be worth considering how a 529 plan fits into your family’s overall financial plan. Like a lot of things in life; starting early, even with small, consistent contributions can make a meaningful difference over time.
-by Jacob Young, AAMS®
Financial Advisor, RJFS
313 East 10th Ave.
Bowling Green, KY 42101
Phone: 270-846-2656
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Ben Smith Life Compass Financial is not a registered broker/dealer and is independent of Raymond James Financial Services.
Investing involves risk and you may incur a profit or loss regardless of strategy selected. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
This content was created with the assistance of artificial intelligence (AI). While efforts have been made to ensure the quality and reliability of the content, it is important to note that AI-generated content may not always reflect the most current developments or nuanced human perspectives.
529 plans come with fees and expenses, and there is a risk they may lose money or underperform. Most states offer their own 529 programs, which may provide benefits exclusively for their residents. Please consider whether the state plan offers any tax or other benefits. Tax implications can vary significantly from state to state.
Raymond James and its advisors do not offer tax or legal services. You should discuss any tax or legal matters with the appropriate professional.
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