What is a 529 savings plan?
A 529 plan is a tax-advantaged education savings plan. Originally, it was designed only to cover postsecondary education costs, but now you can also use it for K-12 education and apprenticeship programs.
The money you contribute to a 529 plan grows tax-free, similar to a Roth IRA and a Health Savings Account. And when you take money out of your 529 plan to pay for eligible expenses, those distributions aren’t taxable either.
Additionally, many states offer either a tax deduction or tax credit for those who contribute to a 529 plan, making it even more attractive for parents who want to save for their children’s education. That said, there are strict requirements to maintain the tax-free status of your contributions and withdrawals.
Using your 529 savings plan for graduate school
While many parents use a 529 savings plan to cover a student’s undergraduate education, 529 plans can also be used to help pay for a graduate degree. If you’re thinking of using a 529 plan for graduate school, here are some things to keep in mind.
Eligible financial institutions
In order to use your 529 savings plan funds for your graduate studies, you must attend an eligible educational institution. In general, that includes any college, university, vocational school or other postsecondary institution that’s eligible to participate in the U.S. Department of Education’s student aid program.
That includes most graduate and professional schools in the U.S., as well as some foreign educational institutions. So whether you’re going to medical school, dental school or business school, the chances are high that you’ll be able to use your 529 plan funds.
Your school should be eligible if it’s on the Department of Education’s database of accredited postsecondary institutions and programs.
A 529 savings plan can be used to pay for qualified education expenses. According to the IRS, that includes tuition, fees and other related expenses incurred by:
- You or your spouse if you file a joint tax return.
- A student you claim as a dependent.
- A third party, including relatives and friends.
Those other expenses can include books, supplies, equipment, room and board (if you’re enrolled on at least a half-time basis), computer-related expenses and special needs expenses. Note that this is only true for 529 savings plans, not 529 prepaid plans, which are a different type of product with more limited uses.
If you take the money out for ineligible expenses, the earnings portion of the withdrawal will not only be taxed as ordinary income, but you’ll also be subject to a 10 percent penalty. In other words, you won’t pay the tax or penalty on what you’ve contributed to the account because that money has already been taxed by the government. But you will be responsible for those charges on any investment earnings you’ve received from the account.
One exception to this rule is that if the student receives a scholarship, they or their parents can withdraw up to the amount of the scholarship and use that money without penalty. You will, however, need to still pay income taxes on the portion of the withdrawal that can be attributed to investment gains.
Changing the beneficiary
In the event that a college student doesn’t need the full amount that was saved for them in a 529 plan, it’s possible to change the beneficiary instead of taking the money for other reasons and paying tax and a penalty. What’s more, changing the beneficiary on a 529 plan is free.
So if there’s another student in your family who didn’t use up all of the funds in their 529 plan by the time they left school, the owner of the account can make you the beneficiary going forward, allowing you to use the money to cover your graduate school expenses.
The bottom line
Using a 529 savings plan for graduate school can make it easier to afford your degree and avoid student loans as much as possible. Before you take that step, though, it’s important to understand both the benefits and drawbacks of 529 plans and how to maximize their value and avoid penalties.
Additionally, you may also want to consider other education savings plans, such as a Coverdell education savings account or a Roth IRA. As you shop around and compare all of your options, you’ll be in a better position to pick the best one for you.
By Ben Luthi