By DAVID DIERKING
Dec. 19, 2022
Families need to save as much as possible as early as possible to get ahead of rising education costs. According to a research report from CollegeBoard.org, the average cost of attending a public four-year college, including tuition and fees, in the 2022 and 2023 school years is $10,950 for an in-state student and $28,240 for out-of-state students. A year at a private college is even more: $39,400.1
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KEY TAKEAWAYS
- A 529 plan allows you to save and grow tax-free money for someone’s education, including your own.
- Beneficiaries must spend the money on qualified education expenses for the withdrawal to be considered tax-free.
- There are two types of 529 plans: prepaid tuition and savings plans.
- Maximum plan contribution limits vary by state, but such limits generally do not apply across states.
Named after the section of the Internal Revenue Service (IRS) code that established them, 529 savings plans are one of the nation’s best ways to save for higher education expenses. These qualified tuition plans allow federal tax-free withdrawal of earnings and the potential for tax deductions, which can help families afford the rapidly increasing cost of college.23
A primary benefit of 529 plans is the high contribution limit. Each state operates its own 529 plan and makes its own rules for the plan, so maximum contribution levels vary across states. Fortunately, 529 limits are usually high enough that most will never have to worry about hitting the ceiling. However, anyone who considers attending a private university might need to save a significant amount of money.
How a 529 Plan Works
A 529 plan allows investors to save and grow money on behalf of a beneficiary, such as a child, grandchild, niece, nephew, or even for themselves. The money grows and can be withdrawn tax-free, provided it is used for qualified higher education expenses (QHEE). These include tuition and fees; certain electronics, such as a computer; books and classroom equipment; and some room and board costs.4
Plan distributions used to pay for non-QHEE items are subject to state and federal income taxes and an additional 10% federal penalty on earnings, with exceptions for certain circumstances, such as death and disability.5 Moreover, you will be subject to income taxation on those non-qualified withdrawals.
There are two main types of 529 plans: prepaid tuition plans, in which the plan holder pays in advance for the beneficiary’s tuition and fees at a specific school, and savings plans, which are tax-advantaged investment vehicles similar to individual retirement accounts (IRAs).6
How Are 529 Contribution Limits Determined?
To qualify as a 529 plan under federal rules, plan balances cannot exceed the expected cost of a beneficiary’s QHEE. The generally accepted guideline is that this limit constitutes five years of tuition, room, and board at the most expensive college in the United States.
This guideline makes investment contribution limits quite large, although every state can individually interpret what five years of qualified education costs means. Potential contributors can check their states’ 529 limits to determine specific investment maximums.7
State-Specific 529 Contribution Limits
All states have maximum contribution limits, the lowest of which are Mississippi and Georgia, at $235,000 per beneficiary. North Dakota is the next lowest, with a maximum of $269,000.7
On the high end, states such as Idaho, Louisiana, Michigan, and Washington, as well as the District of Columbia, have maximum limits of $500,000. Pennsylvania’s limit is $511,758, New York’s is $520,000, and California’s is $529,000.7 Once the limit is reached, any contributions made to the account are not accepted and will be returned to the investor.
These contribution limits apply to each beneficiary. So, for example, in Georgia, which has a $235,000 maximum contribution limit, if parents contribute $200,000 for a beneficiary, grandparents cannot also contribute $200,000 for the same beneficiary.
However, contribution maximums generally do not apply across states. An investor hitting the maximum in one state would likely be eligible to contribute more money in another state’s plan. To be safe, individuals should check with plan administrators first to make sure this is allowed.
$412.5 billion
The amount of assets invested in 529 plans, as of June 2022, according to the National Association of State Treasurers, which hosts the College Savings Plan Network.10
Limit for Repaying Student Loans
Under the SECURE Act of 2019, you can also use a 529 plan to pay off up to $10,000 of your existing student loan debt. Note that this $10,000 limit is a cumulative lifetime limit.11
Gift Tax Considerations
Usually, annual contributions to any individual above a certain threshold ($17,000 in 2023, up from $16,000 in 2022) would count against your lifetime gift tax exemption of $12.92 million for singles and $25.84 million for married couples. This is an increase from 2022's $12.06 million and $24.12 million.12
However, there is an exception made for contributions within a 529 plan. You can give five years' worth of contributions in a one-time lump sum. For example, a grandparent can give an $85,000 one-time lump-sum contribution to a 529 plan ($17,000 per year multiplied by five years) with the understanding that it would cover five years’ worth of gifts. As long as that person doesn’t contribute again in the next five years, there are no tax consequences.13
Fast Fact: Your taxable income is not reduced by contributing to a 529 plan. However, more than 30 states give out tax deductions or credits for contributions made to one.14
Who Can Contribute to a 529 Plan?
Anyone can contribute to a 529 plan account and name anyone as a beneficiary. Parents, grandparents, aunts, uncles, step-parents, spouses, and friends are all allowed to contribute on behalf of a beneficiary.
How Much Can I Contribute to My 529 Plan Per Year?
You can contribute as much as you like each year, provided you don't surpass the maximum contribution limit set by the state in which the 529 plan is registered. It's worth noting, however, that 529 contributions are treated by the IRS as gifts and thus may be subject to taxation when totaling more than $17,000 in a year or $85,000 over five years.15
Do 529s Have a Maximum Contribution Limit?
Yes, there is a maximum contribution limit for each beneficiary. These limits depend on the state and range from $235,000 to $529,000.
Article Sources:
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- CollegeBoard.org. "Trends in College Pricing Highlights."
- Internal Revenue Service. "Topic No. 313 Qualified Tuition Programs (QTPs)."
- U.S. Securities and Exchange Commission. "An Introduction to 529 Plans."
- Office of the Law Revision Counsel: United States Code. "26 USC 529: Qualified Tuition Programs: (3) Qualified Higher Education Expenses."
- U.S. Securities and Exchange Commission. "An Introduction to 529 Plans: How Does Investing in a 529 Plan Affect Federal and State Income Taxes?"
- U.S. Securities and Exchange Commission. "529 Plans."
- College Savings Plans Network. "Find My State's 529 Plan."
- Internal Revenue Service. “Topic No. 313 Qualified Tuition Programs (QTPs).”
- 115th Congress, 1st Session. "Tax Cuts and Jobs Act." Pages 95 and 96.
- CollegeSavings.org. "Total Assets in 529 Plans Nationally."
- 116th Congress, 1st Session. "Setting Every Community Up for Retirement Enhancement Act of 2019."
- Internal Revenue Service. "Frequently Asked Questions on Gift Taxes: How Many Annual Exclusions Are Available?"
- Internal Revenue Service. "Instructions for Form 709 (2019) Schedule A. Computation of Taxable Gifts: Line B. Qualified Tuition Programs (529 Plans or Programs)."
- Saving for College. "How Much Is Your State’s 529 Plan Tax Deduction Really Worth?"
- Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2023."
Matthew Etter, CFP®
Daniel DiVizio, CFP®, CRC®
