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What's a 529 savings plan?

A 529 savings plan is a type of account that you can use to save for qualified education expenses. Many parents choose to save into a 529 account as a way to set aside money for their children's future education, although a 529 can be opened and used for anyone, even your own education!

Each state has its own version of the 529, although most states allow anyone to use their accounts and the account beneficiary can use the money in the savings plan to attend school in any state. (Note that prepaid 529 plans may not have the same flexibility – this article is specifically about the savings plans)

Tax benefits

Many states offer residents a tax deduction for contributions to that state's plan, and a select few states even give you a deduction for contributions to other state's plans. There are reasons you might decide to open a 529 with a different state than where you live, like if your state doesn't have income taxes, it doesn't offer a deduction, or if you simply don't like the investment options available in your state's plan.

One of the benefits of a 529 savings plan is that you can invest your savings and any income or growth of those investments will be tax-free as long as the money is used for qualified education expenses such as tuition, fees or books for college classes. You can even use up to $10,000 per year from your 529 plan to pay K-12 tuition.

Who can use 529 plans

Each 529 account can only have one beneficiary at a time, so if you have more than one child, you'll probably want to open an account for each of them. However, an individual can be a beneficiary on more than one 529, so if, for example, you have two children, each with their own 529, but only one of them decides to attend college, you can still use the second account for the college-bound student. In fact, you can transfer the beneficiary of a 529 account to anyone in your family, including yourself, your parents or even your grandchildren.

What happens with leftover money

If, after all is said and done, there is money in a 529 savings account that will not be needed for future education expenses of anyone in your family, you are able to withdraw the funds for other purposes. You'll just have to be prepared to pay income taxes on any growth along with a 10% penalty on the same amount.

Gift tax rules

All 529 plans have a lifetime contribution limit, but there are no income limits on who may use them to save and you can save as much as you want each year, up to that lifetime limit. You do want to be mindful of gift tax rules though, if you're saving into a 529 for anyone else besides yourself or your spouse. Anything you put in beyond the annual gift tax exclusion would be considered a taxable gift, which requires you to file a gift tax return. There is a special rule that allows you to deposit up to 5 years worth of gifts at once, but if you do that, you'll have to abstain from gifting the beneficiary anything else for the next 5 years.

529 college savings plans can be simple, tax-friendly ways to save for education expenses. The website www.savingforcollege.com has detail on each state's plans as well as more details on how these unique savings options work.

Related: College Savings Calculator

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