What Are 529 Plans?

Arin V., EA , MBA

Arin is an Enrolled Agent (EA), authorized to represent taxpayers in front of the IRS, and holds a BA and MBA (Management) degree from California State University, Northridge.

Are you a U.S. expat living overseas who plans on sending his/her child to an American university? If so, then this article will be beneficial for you. You may have heard of the term “529 plan”. Quite simply, a 529 plan is an investment vehicle designed to pay for future expenses associated with college or other types of qualified post-secondary training. The 529 plan is named after Section 529 of the Internal Revenue Code. So what are the benefits of investing in such a plan?

First of all, the earnings in the 529 plan are not subject to federal or state taxation when they are used for eligible college expenses, and the contributions can be deducted on your state tax return. It is important to keep in mind, however, that contributions to this type of plan are only limited to qualified educational expenses of the beneficiary of the account. Further, there are no income restrictions on the individuals who decide to contribute to this plan. In addition, you can also change who the beneficiary of the plan is if the new beneficiary is in the same family.

Also, since this program began in 1996, there have been some changes to it. For instance, the law has expanded the definition of qualified higher education expenses to specifically include computer technology and equipment, as well as Internet access and other related services which are to be used by the designated beneficiary of this plan while enrolled at an eligible educational institution. There is a caveat to this – software that is designed to be used for games, sports or hobbies does not qualify unless it is for a predominantly educational purpose. This means that unless these games or sports are being used to meet an educational requirement, the software does not qualify as an eligible higher education expense.

There are two types of 529 plans, and they are education savings plans and prepaid tuition plans. A savings plan allows the accountholder to contribute money to the plan, which usually consists of investments made to a series of mutual funds. The holder of the account can choose the funds that they want to invest in. How these funds perform will determine how the account either grows or shrinks over time. Many of these 529 plans also have target-date funds, which adjust the holdings in the account. These holdings become more conservative as the beneficiary gets closer to college age. Withdrawals from the 529 savings plan can be used for both K through 12 and college expenses. A 2019 law known as the SECURE Act expanded tax-free 529 plan withdrawals to include registered apprenticeship program expenses as well as up to $10,000 in student loan debt repayment for both the account beneficiaries and their siblings.

The prepaid tuition plan, on the other hand, is only offered by a limited number of states and some higher educational institutions. These plans generally allow you to “lock in” the tuition at current rates for a student that may not be attending college for years to come. However, the prepaid tuition plan is not available for the K through 12 years. Prepaid tuition plans can also grow in value over time and the money that will eventually come out of the account to pay tuition is not taxable. However, unlike the savings plans, prepaid tuition plans do not cover expenses such as room and board. In addition, prepaid tuition plans may have other restrictions such as which particular institutions they may be used for.

Whatever plan you happen to choose, there is another important difference to point out. With a 529 savings plan, your money will have more time to grow and compound. With a prepaid tuition plan, you will most likely be able to lock it in at a lower tuition rate because many institutions raise their prices each year. As with any kind of investing strategy, make sure that you get an early start so that you will have more money saved up for your children when they get to college age. This is even more important when you are an expat, as these sorts of considerations may get overlooked while are you busy living it up in an exotic foreign location and far away from the U.S. Get in touch with us today to discuss the options you have available to you with 529 plans.