529 vs. Other Educational Savings ProgramsSubmitted by 360Blue Financial Strategies on May 22nd, 2023
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, apprenticeship programs, or student loan repayments.1
The main benefit of a 529 plan is that the contributions have the potential to 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
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 if you contribute more than $17,000 in 2023.3,4
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
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, etc.). In comparison, in a 529 plan, the assets are invested in mutual funds, ETFs, and other similar investments, and you don’t get a say in how they are invested. This means that when it comes to asset allocation, you have more control and flexibility with an ESA.
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. In addition to this contribution limit, there are income level restrictions. You can only use an ESA if 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 30.6
Similar to a 529 plan, 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, saving for the future is always a good idea.
This is meant for educational purposes only. Information presented should not be considered investment advice or a recommendation to take a particular course of action. Always consult with a financial professional regarding your personal situation before making any financial decisions.
Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans prior to investing. This and other important information is contained in the fund prospectuses, summary prospectuses and each issuer’s official statement, which can be obtained from a financial professional and should be read carefully before investing.
There is a risk that the investments may not perform well enough to cover the cost of college as anticipated. Investors should also consider whether their state offers any favorable state tax benefits for 529 plans, and whether such benefits are contingent upon use of the in-state 529 plan. Other state benefits may include financial aid, scholarship funds and protection from creditors.
For withdrawals not used for qualified education expenses, earnings may be subject to taxation as ordinary income and a 10% federal income tax penalty.