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WalletPrep worksheet · Life events

What is a 529 plan and how does it work?

Name ____________________ Date __________

Key ideas

  1. Growth is tax-free when spent on school. Earnings skip federal income tax if withdrawals pay qualified costs. Other withdrawals owe income tax plus a 10% penalty on the earnings.
  2. It covers more than college tuition. College costs, up to $20,000 a year of K-12 costs, apprenticeships and up to $10,000 of student loan payments can all qualify.
  3. Leftover money has a way out. Switch it to another family member, or roll up to $35,000 into the student's Roth IRA after 15 years.

Vocabulary

529 plan
A state-sponsored investment account for education. Growth is free of federal income tax when withdrawals pay qualified school costs.
Mutual fund
A fund that pools money from many investors to buy stocks, bonds or other assets, priced once a day after the market closes.
ETF
Exchange-traded fund: a basket of investments that trades on a stock exchange throughout the day, like a single stock.
Beneficiary
The person or group you name to receive an account, a trust or an insurance payout when you die.
Stock
A small piece of ownership in a company. Its price rises and falls with how investors value the business.
Bond
A loan you make to a government or company. It pays you interest and returns your money on a set date, called the maturity date.

Work it out

Lena opens a 529 for her newborn son and sets up $150 a month. She assumes a 6% yearly return before inflation, which is only an assumption.

  1. Monthly deposit
  2. Months to age 18
  3. Lena puts in
  4. Growth at 6%
  5. Balance at 18
  6. Tax-free growth

Check yourself

  1. Which of these is a qualified 529 expense?

    • A. A car for commuting to campus
    • B. College tuition and required books
    • C. A spring break trip
    • D. A student's credit card bill

  2. Kai's 529 has $20,000: $14,000 he put in and $6,000 of growth. He withdraws it all for a non-school cost. What is the 10% federal penalty?

    • A. $2,000
    • B. $1,400
    • C. $600
    • D. $0

  3. What is the lifetime limit on rolling a 529 into the student's Roth IRA?

    • A. $10,000
    • B. $20,000
    • C. $35,000
    • D. No limit

Your turn

Look up your state's direct-sold 529 plan and check two things: whether contributions get a state tax break, and the total yearly fee for the age-based portfolio. If your emergency fund and retirement match are covered, open it with an automatic $25 to $50 a month.

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Answer key

What is a 529 plan and how does it work?

Work it out

  1. Monthly deposit$150
  2. Months to age 18216
  3. Lena puts in$32,400
  4. Growth at 6%$25,703
  5. Balance at 18= $58,103
  6. Tax-free growth$25,703
  1. Over 18 years Lena makes 216 deposits: $150 × 216 = $32,400 of her own money.
  2. At an assumed 6% a year, growth adds $25,703, so the account reaches $32,400 + $25,703 = $58,103.
  3. If the money pays qualified costs, none of the $25,703 is taxed. Returns vary, can be negative, and this is not a promise.

Check yourself

  1. B. College tuition and required books Tuition, required fees, books, and room and board at an eligible school qualify. Cars, trips and credit card bills do not.
  2. C. $600 The penalty applies only to earnings: $6,000 × 10% = $600. The earnings are also taxed as income. The $14,000 he put in comes back tax-free.
  3. C. $35,000 The lifetime cap is $35,000, and each year's rollover is capped by the IRA contribution limit. The 529 must be open at least 15 years.