How Much Should You Contribute to a 529? Here’s a Simple Guide

The average cost of college in the U.S. is $35,720 per student per year, according to a report from EducationData.org. For many families, that number seems insurmountable.

One way to save up enough money for college is to contribute to a 529 plan. A 529 is a tax-advantaged investment account designed to help cover education expenses. Many people consider having one to be a smart move for an investing portfolio. If you’re hoping to help your child pay for college, this could be a great tool.

But how much can or should you contribute to a 529? Let’s first look at how 529 college savings plans work, and then answer the question, “How much should I contribute to a 529?”

How 529 plans work

Basically, a 529 is an educational savings plan designed with tax advantages. They are also known as qualified tuition plans or QTPs. You contribute money to the account, choose some investments (usually funds), and the balance could grow over time, depending on market performance. It’s a way of investing money for your child’s future that has the potential to provide better gains than interest from a savings account.

When making contributions, you choose a beneficiary for the account, usually a child or some other family member. It’s also possible to name yourself as a beneficiary for an account, and it’s also possible to change the beneficiary. If your child doesn’t use all the funds in the 529 for their college education, you might be able to change the beneficiary to yourself (to go back to school) or to a niece or nephew.

Later, you can withdraw the money without paying taxes on the gains — as long as the money is used for qualified education expenses. This can be a way to help reduce the need for student loans or financial aid.

On top of providing a way for you to take advantage of tax-free earnings on investments, a 529 might also make you eligible for a state tax benefit. Some states, such as Indiana, offer a tax credit for contributions to a 529. Others, such as Kansas, offer a state tax deduction, reducing your taxable income. Both these benefits have the potential to reduce your income tax. Check the rules in your state, though. Some states allow you to claim a deduction or credit only if you live in the state and contribute to the state’s 529 plan.

Not every state offers a tax benefit, though. California and Maine don’t provide extra incentives for contributing to a 529. You also won’t receive a tax credit or deduction from the federal government, though you won’t pay federal income tax on your earnings as long as the money is used appropriately for educational expenses.

Learn how 529 plans work in your state so you can take full advantage of any potential benefits.

529 plan contribution limits

The IRS doesn’t offer a lot of guidance on 529 plan contributions. Instead, the IRS says that “contributions on behalf of any beneficiary can’t be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary.”

Contributions to 529 plans are considered gifts to the beneficiary. As a result, if you want to make a contribution, it’s important to pay attention to the annual gift tax exclusion. For 2021, you can contribute up to $15,000 to a 529 plan without worrying about paying the gift tax (which is levied against the gift giver, not the recipient).

It’s possible to make larger contributions to a 529 plan, though, using a special rule. You can contribute $75,000 at once under the assumption that it’s what you would have contributed over the course of five years.

How much should you contribute to a 529?

When answering the question, “How much should I contribute to a 529?” it’s important to consider your individual personal finance situation and budget. Every family has its own individual requirements when it comes to education costs.

Here are some things to consider as you decide how much to contribute to a 529:

Your savings goals

First, it’s important to consider your own savings goals. When breaking down where you should invest your money, don’t forget to think about saving for retirement.

It’s commonly said that there are loans for college, but there aren’t for retirement. Consider first making sure you’re setting aside what you need for retirement. Then, if that goal is met, you can put extra into a 529 for your child’s college expenses.

Consider other savings goals, such as a down payment for a house or how to get out of debt. Although you can put money toward multiple goals at once, the priority might determine how much money actually goes into the 529.

Tax implications

Gift taxes are paid by the giver, so when deciding how much to put into a 529, make sure you consider the tax consequences.

The gift tax exclusion for 2021 is $15,000, so you could put $15,000 into a 529 without paying the gift tax. On top of that, if you want to front-load your 529 contributions, you could choose to make a $75,000 contribution — and avoid making another contribution for five years.

No matter how you do it, though, it’s important to note that what you contribute will also go toward the lifetime gift exemption (though for most of us this won’t be an issue). For 2021, the lifetime cap on gifts that can be excluded from tax is $11.7 million for married couples.

College costs

College tuition continues to rise, with the cost of college tripling in the past 20 years. If your child is young now, the cost of college could potentially be much higher by the time they’re ready to enroll.

In 2021, the average tuition for an in-state college student at a public four-year university is $9,580. For out-of-state students, that tuition rate is $27,437 on average. Private schools are even more expensive, with $37,200 going toward tuition and fees. And those costs don’t even include living expenses like food and room or costs for books and equipment.

Depending on the situation and when you think of student loan interest and loss of income while attending school, it’s possible that getting a bachelor’s degree could cost as much as $400,000 or more over time, according to the EducationData.org report.

By contributing more to a 529 today, you could reduce how much your child ends up needing for student loans. It could mean big savings down the road — as well as a stronger financial foundation for your child if they don’t start off their career saddled with student loan debt.

Financial aid and a 529: What you need to know

It’s important to note that your 529 balance can impact your child’s financial aid package. How the 529 impacts financial aid depends on the account owner. If the 529 is owned by you or your dependent child, the asset is considered a parental asset.

When filling out the Free Application for Federal Student Aid, parental assets are considered. You're allowed about $10,000 in assets, called an asset protection allowance, before your child’s financial aid is impacted. Above that amount, though, and you start seeing a reduction in financial aid. The maximum your child’s aid can be impacted, though, is 5.64%.

Let’s say your 529 has $25,000 in it. Because that is $15,000 beyond the $10,000 asset protection allowance, student financial aid could be reduced by up to $846 (15,000 x .0564). However, there’s a good chance the tax-free gains in the account total more than that, which makes it worth the reduction.

On the other hand, assets owned by the student, such as a custodial account, can reduce financial aid by up to 20%. That’s a much bigger blow.

When filling out the FAFSA, you don’t have to list assets in a 529 owned by a grandparent. However, those assets can have an impact later, as the withdrawals come as a way to pay for school.

For example, if a grandparent pays for your child’s education using money from a 529, the gains won't be taxed for the grandparent. However, the money will be considered untaxed income for the child. This counts as income for your college student — even though they weren’t working. This money might not be taxed when a student files taxes, but it will count as income when they fill out the FAFSA and apply for student aid in a subsequent year. In fact, it could reduce the amount of the aid package by quite a large amount of money.

It’s possible to mitigate some of the impacts by having the grandparent roll the money into a 529 held by the parent, but it’s still important to run the numbers and be aware of the situation. If you have questions about your specific situation, you might want to speak with a financial advisor.

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Bottom line

Using a 529 plan can help you save for your child’s college a little bit at a time. As the investments earn money over time, it’s possible to withdraw the earnings without paying taxes on them — as long as the money is used for qualified expenses. With the help of a 529, you can potentially reduce the need for student loans and other types of financial aid.

If you’re hoping to open a 529, you can consider opening an account with Wealthfront, which is one of the only robo-advisors that offers a 529. You can read our Wealthfront review for more information.

FinanceBuzz is not an investment advisor. This content is for informational purposes only, you should not construe any such information as legal, tax, investment, financial, or other advice.