For many people, helping to pay for their children’s or grandchildren’s education is one of their main financial goals. It’s admirable to want to put your wealth toward bettering the next generation.
What education savings programs are right for you? A 529 plan is one of the most common educational investment options, but there are other choices. Let’s explore the different programs to help you determine which one is right for you.
A 529 plan is an investment account that offers tax benefits when used to pay for qualified education expenses for a designated beneficiary. These educational expenses could include a variety of things, including tuition for college or K–12 education, trade schools and apprenticeship programs, or student loan repayments.1
The main benefit of a 529 plan is that the contributions grow tax-free, and if the money is used for eligible educational expenses, the withdrawals are also tax-free. In addition to this, over 30 states also offer a tax deduction or credit for 529 plans. For example, in New York, contributions to a New York 529 plan of up to $5,000 per year by an individual and up to $10,000 per year by a married couple filing jointly are deductible when computing New York taxable income.2 If you live in Texas or one of the other states without a personal income tax, then it’s not important to use your state’s 529 plan and can choose from any of the state 529 plans offered
Another benefit of 529 plans is that they don’t have any annual contribution limits (although depending on where you live, they may have a lifetime contribution limit). This means you can save as much as you want for your family’s education. However, you may have to pay a gift tax (or, more likely, you may simply need to file a gift tax return reducing your estate and gift tax unified credit) if you contribute more than $17,000 per child in 2023 (the amount doubles to $34,000 per child if married and you elect to split your gift).3,4
Finally, the beneficiary for a 529 plan is transferable, which means that if your intended beneficiary doesn’t end up using the funds for education, you can transfer the account to another beneficiary in your family. This could include a spouse, in-laws, children, nieces, or nephews, first cousins, aunts, uncles, or in-laws.5
The SECURE Act 2.0 recently passed allows unused 529 funds to be rolled into a Roth IRA in the beneficiary’s name without any penalties or taxes beginning in 2024. While there are certain eligibility requirements that must be met to take advantage of this rollover, including the 529 plan being open for at least 15 years, annual rollovers not exceeding IRA contribution limits, and a lifetime rollover cap of $35,000, this new provision minimizes the previous risk of over-contributing and unused funds being subject to penalties and taxes if not used for qualified education expenses.
Educational Savings Account (ESA)
An education savings account, or ESA, is another educational savings program available to people who want to help contribute to their child’s education costs. There are a few main differences between an ESA and a 529 plan.
The first difference, and benefit, of using an ESA is that you have more flexibility in how your contributions are invested. You can choose almost any investment (stocks, bonds, mutual funds, ETFs, etc.) compared to the limited investment funds selected by each state’s 529 plan. In addition, some state 529 plans have administration and investment fees that may be higher than what you could do on your own. This means that when it comes to asset allocation, you have more control and flexibility with an ESA and no administration costs.
But while you might have more control over your investments, you also have less flexibility regarding contributions and withdrawals. One primary consideration is that you can only invest $2,000 per year per child in an ESA assuming that you fall below the income limits (you make less than $110,000 as an individual or $220,000 as a married couple filing jointly).6,7
Finally, there are more restrictions when it comes to the beneficiary. A 529 plan has no restrictions on the beneficiary’s age. With an ESA, you can only open accounts for beneficiaries who are under 18 and can only make contributions until they’re 18. Also, all funds need to be withdrawn before the beneficiary turns 30 unless the beneficiary is changed before age 30. In contrast, 529 plans allow funds to remain indefinitely, at which time you could change the beneficiary to another individual such as a sibling, grandchild, or great-grandchild.6
Similar to a 529 plan, with an ESA your contributions grow tax-free and can only be used for educational expenses. One difference is that ESAs include other K–12 expenses outside tuition, while 529 plans do not.Contributing to your loved one’s education is beneficial for them and can be a smart strategy for saving on taxes for you. Whether you invest in a 529 plan, an ESA, or another option, such as a custodial Roth IRA, saving for the future is always a good idea.
This content is developed from sources believed to be providing accurate information, and provided by Strategic Financial Planning, Inc. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered legal, investment, or tax advice.