529 Plans and Saving for Education

529 Plans

Written by Jeff Dvorachek

January 3, 2019

According to the Wall Street Journal, the average college graduate has student loan debt of over $37,000, and as a group, the Federal Reserve Bank of New York says the amount is over 1.3 trillion dollars. This student loan debt is really affecting the new graduate’s ability to start their lives and even buying a home. A lot of these things are being delayed because they have a large student loan debt.

Starting a college savings plan can help reduce this debt and help with the student loan crisis. Click the orange circle below to listen in.

Other than taking out loans, what can students and parents do to save for college and maybe even save some money on taxes?

The biggest thing is to start early. The IRS really gives you two ways to be able to save for college on a pre-taxed or on a tax-deferred kind of basis.

Education Savings Account (ESA)

  • $2,000 after-tax per year per child
  • Grows tax-free if used for college expenses
  • There are income limits
  • Must be used by age 30
  • Can be transferred to other family members

529 Plans

  • Contribution limit is much higher (after tax federal)
  • Tax deduction available in some states
  • Grows tax-free if used for college expenses
  • No income limits on contributions
  • Can be transferred to other family members

The first one above is an Education Savings Account, sometimes called an “ESA”. What the ESA says is that you can put up to $2,000 per child into an account. You don’t get a tax deduction for this, but you do get to put the $2,000 away. This amount grows tax-free as long as those funds are used for college. The disadvantages are that you have to fit within certain income limits in order to take advantage of this plan, and these funds must be used by the age of 30. On the other hand, it is nice because you can transfer these funds to other family members.

What happens if these funds are not used by the age of 30? Does that money just go away?

It does. What happens is that money has to come out and you have to pay taxes on it as it comes out, along with potential penalties.

But another thing you can do that has become very popular is set up a 529 Plan. 529 Plans are state sponsored plans with much higher contribution limits. Each state has their own, but you can put significantly more dollars into a 529 Plan. Once again, after-tax dollars is what gets put into here. Some states, such as Wisconsin, will allow a tax deduction for some of the money that you put into these accounts. So, although you don’t get a federal tax benefit for it, at least you get a partial state benefit for it. These funds grow tax-free and if used for college expenses, what you are really saving is the tax on that growth along the way. For 529 Plans there are no income limitations so anyone can do it. You can do it, your parents can do it, and grandparents can do it, which is really nice. This can also be transferred to other family members and it doesn’t have that age 30 limitation.

What kind of education expenses can these plans pay for?

Pretty much everything you can think of for school. It can pay for tuition and fees. It can pay for room and board, including food. Now, you have to be at least a half-time student in order to have the room and board and food be an expense. In addition, it doesn’t matter if you live off campus or on campus. The only thing is that if you live off campus, the amount you can deduct is limited to what you would have paid if you lived on campus. Then there are also other things, such as books, supplies, and equipment. You can actually use these funds to reimburse yourself for a computer. Therefore, if a child needs a computer going into school, including software, that can be used also.

There are certain things a 529 Plan cannot be used for. It cannot be used to pay your student loans, and it cannot be used for travel expenses as you are bringing your child to and from school.

But there are other ways that you can pay for college, above and beyond an Education Savings Account or a 529 Plan, and that would be with scholarships. In addition, there is always gifts from parents and working.

Do you have to pay tax on scholarships as income?

No you do not, as long as your scholarships are not more than your tuition. Obviously, if you have scholarships and your tuition, and some of these other costs are less than that, the difference is generally taxable.

Please contact us for further information or ask about 529 plans and saving for education.

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Jeff Dvorachek
I joined Hawkins Ash CPAs in 1998. I am the partner-in-charge of the Manitowoc, WI, office and tax director for the firm. I have thorough experience providing tax services to individuals, commercial businesses, nonprofit entities and estates and trusts. I also provide compilation and review services. I lead the Tax Committee and am a member of the Information Technology Advisory Committee.

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