Are 529 Plans State-Specific?

For many parents, a popular goal is to help their kids pay for future education costs. One way that can be done is through a 529 plan.

These plans can help you save and are designed to grow tax-free dollars for qualified education expenses later on. However, there are some details about 529 plans you'll need to know as you consider your options. For example, one of the most common questions a parent may ask is are 529 plans state-specific? Something else to consider is if you should invest in an out-of-state 529 plan instead of an in-state one and the implications of each. Here's where to begin.

What Is a 529 College Savings Plan?

There's no doubt the cost of higher education is rising. According to a 2023 report from the College Board, the average year of tuition at a four-year public university is $11,260, and $41,540 for a private school.¹ Those numbers make figuring out how to pay for college more important than ever, especially if you have young kids. One tool to help you save for college is a 529 college savings plan.

A 529 plan is a state-sponsored investment account where you invest savings into the investment options available in the plan, and depending on market activity, it may grow. The savings and earnings (if any) can then be used to pay for qualified educational costs. While most individuals use the plans to pay for college or university tuition, money from a 529 can also go toward room and board, books and fees. These plans can also apply to qualified community colleges and technical schools. Savings from these plans are designed to not significantly impact financial aid applications.

Anyone can open up a 529 plan — not just a parent — and after-tax contributions are tax-deferred, which can help savings grow (although market fluctuations mean there's no guarantee of growth). Then, when it's time for your child to use the funds in the account, you can access the money tax-free as long as the money covers qualified educational expenses. And thanks to a 2017 law, the IRS now allows up to $10,000 from a 529 to be used to pay for student loans.²

How the SECURE Act 2.0 Impacts 529 Plans

The SECURE Act 2.0 is a 2021 bill that helps enhance some retirement planning benefits, it includes some changes to 529 plans. Starting in January 2024, a provision from the SECURE 2.0 Act begins for 529 plans, allowing plan owners to roll over funds from a 529 account to a Roth Individual Retirement Account (IRA) tax-free for the same beneficiary after the account has existed for at least 15 years.

This may help allievae some concern about what to do with funds if they aren't needed for educational purposes any more. Previously, any funds withdrawn for non-qualifying educational expenses saw a 10% tax penalty. Now, 529 owners can take unused educational funds and potentially help start an IRA for a child or grandchild.

However there still are some limitations around transfers, including:

• The 529 educational savings plan must have been open for at least 15 years to be eligible to transfer funds to a Roth IRA.
• The money transferred must go to a Roth IRA in the beneficiary's name, not the 529 account holders.
• A maximum of $35,000 can be rolled over. This is the lifetime limit.
• Transfers still must meet IRS rules on Roth IRA limits. In 2024, the maximum contribution is $7,000 for those under 50 years old.⁴
• Contributions (and any earnings on them) made to the 529 plan in the last five years aren't eligible.
• Roth IRA income limits don't apply, but the beneficiary must have earned an income equal or greater to the transfer amount.

Lastly, as this new provision is coming on line in 2024, state plans may offer additional guidance or limitations on these roll overs. So it may be something to review with your 529 plan provider and a financial professional before making any changes.

How Do Types of 529 Plans Differ?

There are two primary varieties of a 529 plan. One is a college savings plan. The other is a pre-paid tuition plan.

With a savings plan, you open an investment account with the potential to grow your contributions over time. You can use money from the account at most colleges and universities across the country to cover tuition, room and board and other qualified expenses.

With a pre-paid tuition plan, you purchase college credits at today's cost for future use. As costs tend to rise over time, the assumption here is that you'll have locked in some tuition expenses, if not all, at a lower rate. There are a few caveats to the pre-paid tuition plan, however. For example, there are far fewer participating schools and, depending on your plan, the credits may only be used for a specific school. In addition, the money from this plan can only be used for tuition.

Can I Open an Out-of-State 529 Plan?

For the most part, plans are open to residents of any state. So, if you live in Mississippi, you can invest in Ohio's 529 plan. However, keep in mind that some states have special advantages and benefits for residents of that state selecting an in-state 529 plan.

Most often, those benefits are seen in the form of tax deductions or credits. Some states also offer out-of-state benefits to those who work in-state. New York is one example.

There are, of course, some exceptions to the rule. A handful of states do limit their plans to residents, and most pre-paid tuition plans are limited to schools in that state. If you are working with a financial professional who is helping you with your college fund planning, make sure to get a clear understanding of any particular benefits to staying within your state.

Factors to Consider When Choosing a 529 Plan

Most states offer 529 plans. You might wonder, are 529 plans state-specific? The answer is yes — for the most part.

Some states' plans have different advantages over others. Since the 529 plan originated as a federal program, each state-sponsored plan must meet a set of minimum rules, such as any gains from a 529 remaining tax-free if used to pay for qualified educational expenses.

One of the hallmarks of 529 savings plans is they offer a lot of flexibility. However, with so many states having plans — and some states having multiple plans — that equals a lot of choices. That can sometimes feel overwhelming. Accordingly, it's important to consider some key factors when deciding which plan is the right one for you.

Here are some things to consider as you shop around:

• The type of plan: Choosing a 529 savings plan can offer more flexibility in options when it's time for your child to go to college. For example, if they know they want to attend an in-state university, the pre-paid tuition plan may be an option to explore, even though it offers more limited options. On the other hand, if you want access to more options, a college savings plan may be the better bet over a pre-paid tuition plan. Just make sure to check if the plan you go with has exclusions for particular schools (even though it's rare).
• Investment options: It's important to consider your risk tolerance and plan options. Some people may choose to invest in mutual funds on an age-based sliding scale, which may lower risk over time, while others may gravitate toward higher-risk/higher-return plans. Determine what you are comfortable with as you view the available options.
• Taxes: Review your state's rules regarding tax benefits. Then compare your options with other states. If your state doesn't have income tax advantages, another state's plan may have lower fees, which could be an important deciding factor.
• Fees: As with most other investment vehicles, you'll have fees to consider. These can vary widely by state. According to a study from Saving for College, fees for the lowest-cost 529s for out-of-state plans range from $51 in Texas to $964 in West Virginia.⁵ Some fees may be lower for in-state residents.
• Contribution limits: Be sure to look at allowed contribution amounts. This is important both to start your plan and to know what the maximum limit is. Some states have very low (or no) minimum contributions to get started. Other 529s may have an upper limit on contributions. Most states have a maximum limit between $200,000 and $350,000.
• State-run or advisor-run: Some states offer 529s through financial advisors. While these plans may have higher fees, an advisor may be able to do much of the research and guide you toward the in- or out-of-state program that works well for your needs.
• Financial aid: Some states offer special incentives for financial assistance — including scholarships — especially for in-state residents using 529 plans. So, check and see if your state is one of them and how much you may save.
• Contribution ease: As with a 401(k) or individual retirement account, you want to check and see if the plan you're considering is easy to understand and contribute to. If it feels complex or the site is hard to navigate, it may not be the right option for you.

There are a lot of factors to think about. It helps to work with a knowledgeable financial professional who can look at all the numbers and see if a few plans stand out as good fits for your unique needs.

5 FAQs for In-State and Out-of-State 529 Plans

Even after doing your research, you might still have a few questions about 529 plans and how choosing an out-of-state plan matters. Here are five of the more common questions parents ask about 529s and residency.

1. Can My Child Go to a School Outside of My State's Plan?

Yes, as long as there is no specific school exclusion or you're required to go to an in-state school because of a pre-paid tuition requirement. For example, if you live in Illinois and have a 529 plan from Texas, your child can go to school in California and take advantage of the savings from the 529 plan.

2. Can I Change My Plan to a Different State?

You can transfer existing 529s between states. However, check with a financial professional and a tax expert beforehand. Depending on the state, you could have to pay taxes on the earnings in your plan. On the other hand, you may benefit from tax advantages in your new state, so weigh both options before making a final decision.

3. Do I Need to Change My Plan If I Move to a Different State?

No, you don't have to make changes if you move to another state. However, you may want to consider it if you move to a state that offers some income tax advantages. You could find that the benefits of the new state outweigh any penalties you may suffer from the transfer.

4. Do I Still Get an In-State Tax Benefit If My Child Goes to School Out-Of-State?

Yes, you can contribute to an in-state 529 plan, get the residential tax benefits (if your state offers them) and still use the money from your account to pay for your child to go to school out of state.

5. My State Doesn't Have an Income Tax: Does That Matter?

If your state doesn't have an income tax, you may not receive any tax advantages for picking an in-state plan, so it could make any of those advantages moot. Instead, an out-of-state 529 plan may be something to explore, especially if they have lower fees than your in-state plan.

Choosing the Option That Better Addresses Your Needs

While the flexibility of 529s is an advantage, having so many plans to choose from can feel overwhelming to start. That's where working with a trusted financial professional can help. They can work with you to go over your college savings plan and suggest 529 plans that may fit your needs, even if the best choice is to go out of state.

Keep in mind, not all financial professionals are able to sell all plans. Be sure to ask if your professional can sell your state's plan or if they can only recommend an out-of-state plan for you.

   Grandparent-owned 529 plans can reduce the impact on financial aid calculations. Invest Today  

Sources

1. Trends in College Pricing and Student Aid 2023. The College Board. https://research.collegeboard.org/media/pdf/trends-college-pricing-student-aid-2021.pdf.
2. Topic No. 313 Qualified Tuition Programs (QTPs). Internal Revenue Service. https://www.irs.gov/taxtopics/tc313.
3. Saving for college: The new 529-to-Roth IRA transfer rule. Journal of Accountancy. https://www.journalofaccountancy.com/news/2023/mar/saving-college-new-529-to-roth-irs-transfer-rule.html.
4. 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000. Internal Revenue Service. https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000.
5. 529 fee study. Saving For College. https://www.savingforcollege.com/529_fee_study/.