529 Savings Plans: A Unique Tax-Free Tuition Account

November 4, 2021

Career / Business, Planning & Saving

Getting to Know 529s

Tax-sheltered 529 college savings plans have been around since 1996. But since attending expensive universities isn’t a priority for most frum families, these plans don’t really play a role in frum financial planning.

However, during President Donald Trump’s first term, these tools were expanded to allow $10,000 annual tax-free withdrawals, per student, toward K–12 school tuition. This change increased their utility significantly for frum people. Some states, including NJ and MD, also include nifty tuition savings or bonuses via their 529 plan. So it’s high time to explore these powerful wealth enhancers more carefully. They are a bit tricky, and 529 misconceptions abound, so hang on.

What is a 529 Savings Plan?

As college costs kept rising and the economic value of higher education grew, Congress passed and updated laws (in 1996, 2001, 2006, and 2017), offering tax discounts for college savings within special 529 plan accounts. These plans are set up and overseen by states, which delegate day-to-day operations to investment or trust companies such as Fidelity, Vanguard, and Ascensus. Most states have two 529 plans, one offered via brokers and another “direct” option, allowing savers commission-free access to a 529 plan. This is why there are so many 529 plans out there—approximately two for each of the 50 states.

Some 529 Basics

All the plans follow the same basic structure. The account owner fills out an application, opening a 529 account to save money toward someone’s future education. That someone, known as the account’s beneficiary, can be anyone—yourself, a child, a grandchild, a nephew, or even some kid from your shul. The account is then funded with cash to be invested into one or more of a small menu of mutual funds offered by the plan. These investments grow tax-free. This means that as long as they are withdrawn only for “qualified education expenses,” the dividends, interest, and gains are not taxed, ever.

Compare to an Unlimited Roth IRA

Most states, including New Jersey and New York, follow federal rules for 529 plans. Considering that combined top tax rates for investment gains and income can easily reach 25–50%, tax-free investment growth increases net investment wealth massively. The tax structure offered here is similar to that of a Roth IRA. But unlike the Roth, 529 plans can be funded by anyone, regardless of income. And whereas retirement accounts limit annual contributions to as little as $14,000 per couple, in 2025, 529s can be funded in an almost unlimited capacity. As a long-term investment vehicle, 529 plans offer a lot of scope for creative tax-free investing.

Minimal Short-Term Benefits

Unfortunately, 529 plans do not offer the significant immediate tuition assistance that Klal Yisrael needs so badly (see breaking news above!). The federal government offers no tax deductions or credits for money deposited in 529s, and most states offer minimal deductions. For example, NJ and NY have a measly $10,000 deduction (per couple) for 529 contributions. This deduction will, at most, lower a tax bill by a few hundred dollars annually. Bupkes. The primary largesse offered toward 529 accounts is the non-taxing of future investment growth produced by these sheltered accounts. This benefit is only truly useful for those who can tie up significant funds for years, not cash-strapped young families who need money for tuition now.

Massive Long-Term Benefit

Considering that 529 accounts have certain fees and restrictions, it’s not worth hassling with them for small sums invested for the short term. But say a couple has a solid income that more than covers their current needs, and their simchas and retirement accounts are already funded sufficiently to cover future needs, too. Where are their additional savings headed, for the most part? To help out their kids and grandchildren. And what will be a major part of their children’s financial needs? Tuition. Long-term investing within the cozy tax-free environs of a 529 account can therefore be super beneficial.

Tax-Free Education Investing

For simplicity’s sake, imagine a family that would like to invest toward helping their kids in the future. If they just dump that into a regular portfolio of mutual funds, any withdrawals made would be taxable, significantly diminishing the help they can provide. Instead, they can open 529 accounts, naming their children as beneficiaries. (Down the road they will follow a simple process to open and fund separate accounts for each of their einiklach using their parents’ 529 accounts). Then, every year, tuition funds (up to $10,000 per K-12 and unlimited for higher education needs) can be withdrawn from the 529 accounts tax-free.

Big Bucks Required

It may sound odd to tie up so much money in accounts restricted for education, but let’s think about this. Say a couple has six children who will have an average of six children over the next few decades. The cost of educating just the 36 einiklach will easily be in the millions (36 kids x 12 years of schooling x $10,000 = $4,320,000). Add in higher projected tuition, inflation, beis midrash, seminary, and even kollel housing—an allowed expense under 529 rules—and the figure is much higher. Using a 529 structure, some or all of this “liability” can be covered with tax-free investment growth.

A New Investing World Opens

529 plans are a whole new world for most, with further options, rules, and benefits to explore. One interesting idea is using 529 plans for tax-free simcha savings for children and grandchildren. Money is fungible, so you can withdraw funds to match and reimburse yourself for that year’s education expenses and then use them to fund simchas, or whatever. There’s also tremendous scope to use 529 plans for estate planning. Also, as mentioned, some states, including NJ and MD, have a few 529 perks worth exploring.

New Jersey Perks

For example, New Jersey offers two grants for those using their 529 plans. The first is a $750 match (per account) for those with AGIs (adjusted gross incomes) under $75,000.
Click here for more information from the NJ website.

After three years, those granted funds are unrestricted. Another 529 grant, open to all New Jerseyans, offers as much as a $6,000 scholarship for higher education in New Jersey (including BMG).
Click here for more scholarship information from the NJ website.

Many strings are attached, but this can still add up for those with many kids and/or einiklach. BH, over time, we will publish more details about these unique tax-free investment accounts. Parnassah is hard, and we should try to use every legal trick and tip possible, including 529 plans.