What is Plan 529 and Why You Should be Offering it To Your Employees?
Higher education is one of the largest expenses out there and one that weighs heavily on the minds of employees and their families. As a responsible employer, what you can do is offer a 529 plan. It enables you to cover the education cost of your employees. If you want to further learn about plan 529 and what it has for your employees and you as an employer, continue reading this article.
This article covers the following:
- What is plan 529?
- What are the tax benefits of plan 529?
- What is the difference between a savings plan and a prepaid tuition plan?
- What are the benefits of plan 529?
- What are the disadvantages of plan 529?
- Three reasons why you must offer plan 529 to your employees
- What does offering plan 529 to your employees look like?
- Step-to-step guide on how to go about plan 529.
- FAQs on plan 529
- How can Deskera assist you?
What is the 529 Plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
There are two types of 529 plans college savings and prepaid tuition plans. The college savings version allows earnings to grow tax-deferred, and withdrawals are tax-free when used for qualified education expenses.
Every state offers at least one of these types of plans. Some states offer both, and a consortium of private colleges also offers a prepaid tuition plan.
Prepaid Tuition Plans
A prepaid tuition plan allows you to purchase college units or credits and room and board for future enrollment at a college or university that participates in the plan.
According to the Financial Industry Regulatory Authority (FINRA), most prepaid tuition plans allow you to prepay tuition at participating colleges at today's price. With the cost of tuition rising each year, this can provide big savings for your future scholar. Best of all, the U.S. Securities and Exchange Commission (SEC) says the state backs many prepaid tuition plans.
Keep in mind that many plans require you or your child "the beneficiary" to be a resident of the state that sponsors the plan. Additionally, prepaid tuition plans have a limited enrollment period each year.
Upon enrollment, your payment plan will be determined based on the current age of your child and the number of years of tuition you buy.
College Savings Plans
According to the SEC, a college savings plan allows you to open an account where your contributions will be invested in bond mutual funds, stock mutual funds, or money market funds.
If this sounds like a risky choice, note that most plans choose more conservative investments as the beneficiary approaches college age. However, according to the SEC, college savings plans are not state-guaranteed or federally insured.
College savings plans typically cover any "qualified higher education expenses." According to the SEC, these expenses often include tuition, room and board, mandatory fees, and unlike a prepaid tuition plan, required materials such as books and computers.
College savings plans have no age limits, and you can enroll at any point during the year; however, you’re only allowed to determine your investment options once a year, the SEC says.
What are the Tax Benefits of Plan 529?
A 529 college savings plan works much like a Roth 401(k) or Roth IRA by investing your after-tax contributions in mutual funds, ETFs, and other similar investments. Your investment grows on a tax-deferred basis and can be withdrawn tax-free if the money is used to pay for qualified higher education expenses. Contributions are not deductible from federal income taxes.
You may also qualify for a state tax benefit, depending on where you live. More than 30 states offer state income tax deductions and tax credits for 529 plan contributions. These tax benefits make 529 plans better for college savings than traditional savings or investment accounts.
Some families use 529 plans as an estate-planning vehicle since contributions are considered completed gifts to the beneficiary. Up to $16,000 per donor, per beneficiary, qualifies for the annual gift tax exclusion.
What is the Difference Between Savings Plans & Prepaid Tuition Plans?
Prepaid tuition plans and college savings plans are the two types of 529 plans (also called qualified tuition plans), according to the Internal Revenue Service (IRS). Each type of plan offers tax advantages to help save for college expenses.
Prepaid tuition plans let you purchase college credits or units at today's prices to be used in the future. College savings plans let you invest contributions that can be withdrawn later to help pay for qualified tuition expenses. At least one type of 529 plan is offered in all 50 states and the District of Columbia.
What are the Benefits of a 529 Plan?
Here are some of the benefits of the 529 plan:
Low Maintenance
A 529 plan account can be opened online or through a licensed financial advisor. Families who prefer to “set it and forget it” can select an automatic investment plan linked to a bank account or payroll deduction plan. The program manager handles the ongoing investment management within a 529 plan.
High Contribution Limits
Unlike other savings plans, such as a Roth IRA or Coverdell Education Savings Account, 529 plans have no annual contribution limits and high aggregate limits. Maximum aggregate limits vary by state, ranging from $235,000 to $529,000.
529 plan contributions are considered completed gifts to the designated beneficiary for tax purposes. In 2021, up to $15,000 qualifies for the annual gift tax exclusion.
There is also an election to contribute as much as $75,000 in one year without generating a taxable gift if the contribution is treated as if it were spread over five years.
Favorable Financial Aid Treatment
When a dependent student’s parent or a dependent student owns a 529 plan, it is reported as a parental asset and has a relatively minimal effect on financial aid eligibility. Distributions from a parent- and student-owned accounts are not counted as income on the Free Application for Federal Student Aid (FAFSA).
Flexibility
529 plans offer the same benefits for all families, regardless of their household income or the amount they contribute. You can invest in almost any 529 plan, whether you live or where your child will attend college.
Everyone is Eligible for the 529 Plan
Unlike Roth IRAs and Coverdell Education Savings Accounts, 529 plans have no income, age, or annual contribution limits. There are lifetime contribution limits, which vary by plan, ranging from $235,000 – $550,000.
Those looking to reduce estate taxes can elect to treat a 529 plan contribution of between $16,000 and $80,000 as if it were made over a five calendar-year period to qualify for the annual gift tax exclusion.
Donor/Employer Stays in Control of the Account
With few exceptions, the named beneficiary has no legal rights to the funds in a 529 account, so you can assure the money will be used for its intended purpose. This differs from custodial accounts under UGMA/UTMA, where the child takes control of the assets once they reach legal age.
A 529 account owner can withdraw funds for any reason but keep in mind that the earnings portion of non-qualified withdrawals will incur income tax and an additional 10% penalty tax.0
Easy Tax Reporting
Contributions to a 529 plan do not have to be reported on your federal tax return. You won’t receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals.
In 2022, deposits to a 529 plan up to $16,000 per individual per year ($32,000 for married couples filing jointly) will qualify for the annual gift tax exclusion.
Chances of Tax Breaks
In addition to the federal tax savings, over 30 states currently offer a full or partial tax deduction or credit for 529 plan contributions. You can generally claim state tax benefits each year you contribute to your 529 plan, so it’s smart to keep making deposits until you’ve paid your last tuition bill.
Be sure to research all of your options. If your state doesn’t offer benefits for residents, you can choose any other state’s plan.
High Return Investment Options
Depending on which plan you choose, each state has its own options. You can invest in stock funds and other market-based investments. That gives you the ability to earn outsize returns on your contributions and the potential to beat the galloping cost of college.
That kind of opportunity, if used correctly, can vastly outstrip saving in a bank account. Every coin has two sides. Likewise, the 529 plan has both its advantages and disadvantages that you must be aware of before getting a 529 plan. Hence, in the next section, we will enlighten you a little about the disadvantages of the 529 plan.
What are the Disadvantages of the 529 Plan?
Here are some of the disadvantages of the 529 plan that you must not overlook:
Penalty for non-qualified withdrawals
Non-qualified distributions are subject to income tax and a 10% penalty on the earnings portion of the distribution. However, there are exceptions to the penalty if the beneficiary gets a scholarship, attends a U.S. Military Academy, dies, or becomes disabled.
State income tax recapture
If a 529 plan account owner does a rollover into another state’s 529 plan, any state income tax deductions and credits previously claimed may be subject to recapture, and the earnings portion of the outbound rollover may be added back to state taxable income.
State income tax recapture
A 529 plan account owner must select from a menu of investment options offered by the 529 plan. This typically includes static investment portfolios that aim to achieve a targeted level of risk, individual fund portfolios, and age-based portfolios that automatically shift asset allocation as the beneficiary gets closer to college.
Fees
The more families pay in 529 plan fees, the less they are able to save for college. Direct-sold 529 plans are less expensive than advisor-sold 529 plans, but expenses can also vary among 529 plan portfolios. It’s important to research your options and find a low-cost 529 plan option that meets your college savings needs.
Ownership rules
The 529 plan account owner, not the beneficiary, has legal control of the money in the account. The account owner can easily change the beneficiary at any time, or worse, they can take a non-qualified distribution and liquidate the plan.
This might become an issue if a parent depends on a grandparent or other relative’s 529 plan to pay for their child’s college education.
Three Reasons Why You Must Offer Plan 529 as an Employee Benefit
Here are few reasons why you must offer plan 529 as an employee benefit:
Reducing Employees’ Financial Stress
Financial stress research from Plan Source and Met Life reports that employees are distracted by their personal finances, and funding education is top of mind for many.
This research finds that by adding tailored, non-medical benefit options, such as 529 college savings plans, employers can increase overall employee satisfaction and retention while helping to reduce anxiety around financial wellbeing.
While the educational attainment challenge is complex, there seems to be consensus around two chief factors: cost and culture. Saving for higher education helps address costs.
Research shows it also helps mold family culture and has a measurable impact on whether a student pursues higher education. Given this, awareness and utilization of education savings accounts such as 529s are vital in raising postsecondary completion rates.
Create Loyalty for Employees
When an employer offers a 529 Program as a no-cost employee benefit, account ownership and payroll contributions increase exponentially. Partnering with their state’s 529 Program allows employers to offer a competitive benefits package that helps attract and retain top talent for organizations while also helping employees invest in themselves and their loved ones.
By providing this type of benefits, employers are encouraging and helping to cultivate and grow the skills they seek for future growth. Education materials and direct payroll deposits are available at no cost.
Employers can also utilize 529s as part of their organization’s rewards and recognition program by directly contributing to an employee’s individual 529 plan. Examples could include 529 gift cards or matched or unmatched contributions for bonuses or celebrating life events such as a work anniversary or a new baby.
With recent legislation making 529 funds available for tuition at K-12 public, private and religious schools, qualified expenses for registered apprenticeships, and repayment of qualified student loan debt, it is easier than ever for employers to get creative in supporting their employees education goals.
As a bonus, some states offer tax incentives to employers for contributions made to employee 529 accounts. A win-win for all!
Employer involvement is important for the cultivation of a more educated workforce. With the rising costs of higher education and the importance of ensuring the future workforce has its needed skills, encouraging families to save for educational expenses is imperative.
Just like 529 college savings have the potential to add up, every investment an organization makes in its business, its employees, and their families make a difference.
529s are a smart addition to any organization’s benefits package, giving employees peace of mind about saving for education, helping employers create organizational loyalty, and fostering a pro-education culture.
Retain Best Talent in Your Company
Invite 529 staff to speak at the benefits fair, a lunch-and-learn, or another event. Distribute 529 program information to employees (newsletter, intranet, and social media).
Provide the option for employees to direct deposit contributions into their 529 accounts. Directly contribute to employees’ 529 accounts. Award organization scholarships through a company-owned 529 account.
Offering Plan 529 as an Employee Benefit
Many employers are searching for more ways of increasing the benefits they can offer their employees. As noted before, employers are carefully watching IRS determination letters for how employers can treat payments on student loans, and many schools and nonprofits are working on new ways to use contributions to 403(b) plans. So it's not surprising that many employers are contemplating contributing to 529 plans similar to their contributions to Health Savings Accounts.
529 plans are tax-advantaged plans that help families save for children’s education. Why families, not parents? Because anyone can contribute to the 529 accounts.
The tax advantages may differ, as we noted last year when talking about gifts of stock and retirement. Those tax advantages are set by states, not by federal rules though the benefit impacts federal income.
Here’s how the IRS defines it, A qualified tuition program (QTP), also referred to as a section 529 plan, is a program established and maintained by a state, or an agency or instrumentality of a state, that allows a contributor either to prepay a beneficiary's qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses.
Most people don’t consider using a 529 account to prepay for tuition. Instead, they think of a 529 plan as saving for college. According to the IRS, the benefits of the 529 plan are:
1) Earnings accumulate tax-free while in the account;
2) Distributions aren't taxable when used to pay for qualified higher education expenses (unless the tuition is less than the amount distributed), and
3) The beneficiary doesn't generally have to include the earnings from a QTP as income.
Employers may want to carefully consider how 529 plans are treated in each state before following along with others in their industry and offering a match to an employee’s contributions.
Things can get pretty complex for employees when it comes to 529 plans. Employees don’t have to choose a plan in their own state or even in the state nearby.
One author wrote about contributing to their niece’s 529 plan in Ohio even though the niece was a resident of California, while the author lived in an entirely different state.
The tax impact and benefits vary from state to state. There are so many plans and varieties that whole websites are set up just to compare them. Additionally, there is sometimes confusion over who owns the assets held by the 529 accounts. In most scenarios, a 529 account is owned by an account holder for a child’s education.
In other words, the account is similar to a trust, with the college-bound child in the position of a beneficiary. The account holder can change the beneficiary whenever they wish. The assets are considered the property of the account holder.
So employers may want to offer contributions to 529 plans but may need to turn the heavy lifting of discussing the pros and cons of that to their financial advisors in terms of employee education sessions.
Among the topics, many employees may be interested in is the impact the 529 plan has on their child’s ability to get financial aid. This topic may be the center of some debate, with sharp opinions on each side.
For a good reason, recall that there are so many 529 plans and permutations that folks have to rely on websites comparing them side-by-side. That means two people who think they are similarly situated (both have similar salaries and tuition burdens) may have different results.
There’s one more nearly impossible to predict variable: the forms schools use to measure assets for the child in need of tuition assistance aren’t necessarily the same. It’s a trap for the unwary.
As one writer pointed out, the factors that go into how a 529 plan impacts a child’s financial aid package are pretty varied: In general, how 529 plans are counted towards your child’s financial aid package depends on the financial aid form used, who owns the 529 plan, and your child’s college’s formula on how 529 plans are counted towards financial aid packages.
Where feasible and appropriate, offer contributions to 529 plans to their employees as part of a benefits package. The employers who offer contributions to 529 plans usually do so through a matching plan similar to contributions to health savings accounts. For example, some employers offer a $1000 match to 529 plans for employees, and others vary their plans.
In short, providing an employer match to 529 plans may hinge not just on whether the employer has the assets but on other factors, like whether an employer can find the information employees may need.
Employers may need to consider whether funds can be divided among 529 plans (for multiple children). The administrative (compliance, paperwork, fund management) of handling the match to the 529 plan may be more than some employers can bear, but for those who can, it can be of great use to employees and their families.
Benefits of Plan 529 for an Employer
Some HR managers feel they already have too many topics to educate employees about and so are hesitant to promote 529 plans. However, they are passionate about the value that the programs can offer not only to employees but to employers.
Employers get to promote financial wellness. They get to educate their employees about something that might be really important to them. It helps to attract and retain employees and improves employee satisfaction overall.
The benefits to employers convinced the city to offer its employees ScholarShare 529. It sounded like a great benefit, and, when we looked more closely, the fact that it wasn't going to cost the employer anything and that there was zero reporting required was a huge plus.
The process was "totally seamless," ScholarShare team has been available to answer questions and handle the administration. Benefit focus offers its own employees access to 529 plans through Gradvisor, Guinn said.
Having around 20 associates immediately enroll within the first month, and we are continuing to see growth as we offer year-round enrollment in this benefit." With a multistate initiative underway to raise awareness of 529 plans, now is a good time to ask whether your employees would value this benefit. Chances are, the answer is yes.
Step to Step Guide For 529 Plan
Here is stepwise guide to go for plan 529
Select a plan
You’ll have to choose between a savings plan or a prepaid plan. According to Gorman, parents can open a plan with any provider, regardless of state — but she recommends prioritizing the quality and cost of the plan you choose to invest in first and then consider any state tax benefits the plan may provide.
This is important as you don’t want to invest in an expensive plan that underperforms just because of the tax benefit accoring to Gorman. Every state and the District of Columbia offers a 529 plan. It is even possible to open multiple 529 plans in multiple states.
However, each state’s 529 plan has its own set of advantages, and they are limited to residents in some cases. For example, there may be a state income tax credit only available to residents of the state offering the plan.
There are other considerations, too, such as enrollment fees and minimum contribution amounts. If you want to know how to open a 529 plan, the College Savings Plan Network (CSPN) has a comparison of 529 plans across different states. It also has a map that lets you easily find your state’s plan.
If you aren’t sure which provider or plan works best for you, consider contacting a financial adviser for advice. A 529 plan broker may also be able to give you assistance.
Choose a beneficiary
This will likely be your child but remember, you can change the beneficiary at any time without penalty. You will need the beneficiary’s date of birth and Social Security number.
Since most plans have age-based options, meaning they have a target-allocated fund that reallocates based on a child’s age, it’s best to open an individual account for each child.
In general, anyone can be the beneficiary of a 529 plan; it is not limited to children or any other type of relationship. The beneficiary must be a U.S. citizen or resident alien and have a social security number or tax identification number.
As long as those requirements are met, there are no restrictions on whose name can be on the plan. In fact, even the person opening the 529 plan can be its beneficiary.
Open the account
Most accounts can be opened online. Once opened, you can deposit funds directly into the account (some plans require a minimum deposit for opening.) Be sure to keep an eye out for any fees associated with providers and plans; there can be annual fees, account opening fees, and percentage fees. Always read the fine print.
The information you will need to open a 529 account may vary by plan. In general, though, expect to be asked for details such as social security number (or tax ID), date of birth, and address. You must provide that information for both yourself (or the person opening the plan) as well as the beneficiary.
A 529 plan works much like other types of investment accounts. Thus, you can employ age-based investment strategies, conservative, moderate, or aggressive investment mixes, or a mix of your own funds. Since these accounts are like other investment accounts in many ways, automatic investments are also an option.
Build your portfolio
If you’ve chosen a savings plan, you can choose where to invest your money. Most providers offer both actively and passively managed investments. These funds are similar to target retirement funds. They automatically adjust the asset allocation based on the child’s age.
That means the funds become more conservative as the date for tapping the funds nears, helping to ensure that you have the money when you need it. If you need help, some plans have advisory fees but are sure to review these beforehand.
It’s really easy. You don’t need to be sophisticated or need someone who is sophisticated to open it for you. Don’t be discouraged because it sounds complicated, because it’s not.
FAQs on Plan 529
Which type of 529 plan is better?
A. It depends upon the education plans, investment needs, and goals of the family. Most states have created innovative college savings programs individually designed to reflect the unique needs of their citizens.
The plans offer affordable, flexible, and tax-advantaged options that can ensure the door of opportunity is open for our children to access post-secondary education. While prepaid tuition plans offer the opportunity to assure future tuition payments, savings plan assets can be used for tuition and other qualified expenses such as room and board.
Some states offer their citizens both types of programs, giving families the option to choose the 529 plan that is right for them. It’s also important to consider that many families choose more than one investment option in order to diversify their college savings portfolios.
Who can be a beneficiary in the 529 plan?
A. Generally, anyone can be named the beneficiary of a 529 account regardless of their relationship to the person who establishes the account. You can even establish an account with yourself as the named beneficiary. The only requirement is that the beneficiary must be a US citizen or a resident alien, and must have a social security number or federal tax identification number. Be aware that the maximum contribution per beneficiary varies between 529 plans.
Can a beneficiary have more than one account?
A. Yes. Since only one account owner can be named per account, family members may choose to open their own account for the same beneficiary.
Be aware that a 529 plan’s impact on financial aid calculations can vary depending on the relationship of the account owner to the student beneficiary.
Can anyone open a 529 account? What about grandparents?
A. Anyone can open a 529 account. Grandparents, other relatives, or family friends can all be account owners or simply choose to contribute to an existing account. A trust, corporation, non-profit, or government entity can also open an account in most states.
Does my child have to go to an in-state school?
A. No. Funds can be used at any eligible educational institution in the country to pay for qualified higher education expenses. “Eligible educational institutions” are accredited post-secondary institutions offering credit toward a bachelor’s degree, an associate degree, a graduate-level or professional degree, or another recognized post-secondary credential.
Certain proprietary institutions, postsecondary vocational institutions, and institutions located in foreign countries are also eligible educational institutions.
To be an eligible educational institution, the institution must be eligible to participate in U.S. Department of Education student aid programs.
What if my child doesn’t go to college?
A. You have several options available if the beneficiary decides not to go to college:
Change the beneficiary to a member of the beneficiary’s family.
Defer the use of your savings and leave contributions invested in the account.
Withdraw the assets in your account for a “non-qualified” distribution (a distribution not used for qualified education expenses). Earnings (but not contribution amounts) would be subject to state and federal tax plus a 10% federal tax penalty on the earnings. Some plans may charge additional fees or penalties on non-qualified distributions.
What if my child is in high school? Is it too late to open an account?
A. It is never too late to save for higher education. You may open an account for an individual of any age, and the account may be used immediately. Note that some prepaid tuition plans may need a longer timeline to see a significant return on investment, so be sure to check with plan administrators.
What if my beneficiary receives a scholarship?
A. You can use your funds to pay for expenses not covered by the scholarship, such as room and board, books, and other required supplies. If you withdraw funds and do not use them for qualified expenses, the earnings portion of your withdrawal may be taxed at the scholarship recipient’s tax rate but will not be subject to the 10% additional federal tax penalty.
Is there age or income limitations for participating in a 529 plan?
A. Anyone can participate in a 529 plan regardless of the income of the account owner and in most states, regardless of the age of the beneficiary.
Q. How do I open a 529 plan?
A. To learn more about a particular 529 plan and open an account, you can contact the state which administers the program directly. CSPN offers information and links to plan websites and toll-free numbers to contact the state plans.
Most states offer residents the opportunity to invest in the plan directly through the state. These plans are often called “Direct Sold” and are typically offered with relatively low fees and without sales commissions.
For those looking for professional advice on how to invest in a 529, “Advisor Sold” programs are offered by many state plans. Advisor Sold programs offer professional investment advice and service with standard sales commissions applying.
Q. How can I change the beneficiary on an account?
A. Each 529 plan makes available all forms necessary for changing the beneficiary on an account. Contact your 529 plan to determine the specific requirements and forms necessary to complete this procedure.
Depending on the relationship of the new and old beneficiaries, changing the beneficiary of an account may trigger a taxable event, which could also include a penalty, gift tax, or both.
Q. Is investment in 529 plans recommended by financial advisors?
A. Many financial planners, tax accountants, and other financial advisors recommend 529 plans to their clients as a program that may fit their college planning needs. You may want to consult an advisor to see if 529 plans would be best for you.
Q. Are there restrictions regarding 529 plans and education savings accounts?
A. Individuals can contribute to both 529 plans and Coverdell Education Savings Accounts. The Economic Growth and Tax Relief Reconciliation Act of 2001 permits contributions to the Coverdell Education Savings Account to cover K-12 education expenses on a tax-favored basis.
Individuals may benefit by funding a 529 plan for the child’s college expenses and utilizing the Coverdell Education Savings Account for elementary and secondary education expenses. Note that the annual contribution limit for Coverdell accounts is $2000 per beneficiary.
Q. Once an account is established, who controls the investments?
A. Many states contract with an investment manager to work with the state to develop investment portfolios and options that will help investors meet their college savings needs.
Federal law prohibits the investor from having direct control over the selection of specific investments; therefore the state and the investment manager typically offer multiple savings options for the investor to choose from when they open an account. The account owner may change investment options subject to certain federal tax law limitations.
How Can Deskera Assist You?
With all this data, you need software that can help you manage it. With Deskera, you get a dedicated bookkeeper and powerful reporting software for a clear view of your financial health.
Key Takeaways
- A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs.
- There are two types of 529 plans, prepaid tuition plans and college savings plans.
- A 529 college savings plan works much like a Roth 401(k) or Roth IRA by investing your after-tax contributions in mutual funds, ETFs, and other similar investments.
- Prepaid tuition plans let you purchase college credits or units at today's prices to be used in the future.
- College savings plans let you invest contributions that can be withdrawn later to help pay for qualified tuition expenses.
- A 529 plan account can be opened online or through a licensed financial advisor.
- 529 plan contributions are considered completed gifts to the designated beneficiary for tax purposes.
- Non-qualified distributions are subject to income tax and a 10% penalty on the earnings portion of the distribution.
- Financial stress research from Plan Source and Met Life reports that employees are distracted by their personal finances, and funding education is top of mind for many.
- Employers get to promote financial wellness. They get to educate their employees about something that might be really important to them.