What is a 529 plan? And how is it different from most other types of accounts? First of all, anyone can open an account, regardless of your income or age.
With an IRA or 401(k) you are limited to the amount you can put into an account. With a 529 plan there is no annual limit to how much you can contribute, other than any gifting limitations. But even with the gift limits you can still contribute an unlimited amount. However, there is a limit to how big your 529 account can get. This limit is specific to each state. Some states allow your account to grow up to $200,000 while others allow up to $500,000.
This is another characteristic of a 529 plan, that it is recognized at a federal level but operated and managed at a state level. The 529, just like a 401(k) or 403(b) is a code section or chapter in the IRS tax code that allows all of this to work.
How does a 529 plan work?
You put money into this account and may receive a state tax deduction, but nothing at the federal level. The account will grow and depending on how the funds are used will decide if the growth is tax free. If the funds are used for qualified education expenses the funds can be used tax-free. Think of five things that are considered qualified education expenses: tuition, books, supplies, room and board, and now a computer. So if you use the funds from your 529 for qualified education expenses they will be tax free, whether it comes from your contribution, growth, or earnings.
If you have to use the funds from your 529 for anything besides qualified education expenses there will be tax and a penalty. This is calculated on the earnings in proportion to your contributions. It gets prorated. This can be a great account to use especially if you have several years until college for your child!
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