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Saving for College: Benefits of a 529 Plan

Saving for College: Benefits of a 529 Plan

May 05, 2023

Texas 529 college savings plans are an excellent option for families looking to save for their children's future education expenses. These plans are tax-advantaged, meaning that any earnings on the investments are tax-free as long as the funds are used for qualified education expenses.

Texas offers two types of 529 plans: the Texas College Savings Plan and the LoneStar 529 Plan. The Texas College Savings Plan allows for investments in a variety of portfolios, including age-based and custom options. The LoneStar 529 Plan is a prepaid tuition plan that allows families to lock in current tuition rates at Texas public colleges and universities.1

Both plans have no income restrictions, and contributions can be made by anyone, including grandparents and other family members. There are no annual contribution limits, but there is a lifetime contribution limit of $500,000 per beneficiary.2

529 plans come with a range of benefits that are particularly advantageous for grandparents. These include reducing their estate tax exposure, retaining control of the assets throughout the account's life, ease of management, and flexibility. There is no need to worry about the impact on federal financial aid anymore, as the FAFSA simplification scheduled to be rolled out for the 2024-2025 award year will no longer require grandparents' financial support to be reported.3

Similar to most 529 plans, the Texas 529 plans offer state tax benefits that align with the federal tax benefits. These benefits include:

  • Eligibility for the annual gift tax exclusion of $17,000 ($34,000 for couples filing jointly)4
  • Eligibility for 5-year gift tax averaging, allowing contributions of up to $85,000 ($170,000 for couples filing jointly) without incurring gift taxes4
  • Accumulation of earnings on a tax-deferred basis
  • Complete tax exemption for qualified distributions for K-12 tuition and qualified higher education expenses
  • The earnings portion of non-qualified distributions is taxed at the beneficiary’s rate and is subject to a 10% federal tax penalty.

There are a few special exceptions to the 10% penalty rule, including when the beneficiary becomes incapacitated, attends a U.S. Military Academy or gets a scholarship. In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out penalty-free, but you’ll have to pay income tax on the earnings. 

The Texas 529 plan does not offer tax-deductible contributions for state income tax returns. This is because Texas is one of nine states without state income tax, so there are no tax deductions or credits available for contributions to the state's 529 plan.

Another benefit of Texas 529 plans is their flexibility. If the beneficiary decides not to attend college or receives a scholarship, the funds can be transferred to another family member or used for other qualified education expenses, such as trade school or continuing education.

Did you know that Texas residents are not limited to investing in their own state’s plan? Another state may offer a plan that performs better and has lower fees. Select your state below to see your state’s plan and other options.

You can also use a 529 plan to pay for more than just college tuition. For example, let’s say your child wins a full-tuition scholarship that pays for tuition and fees to attend Duke University. In this case you might still be able to take a tax-free withdrawal from your 529 plan, since qualified higher education expenses under Internal Revenue Code Section 529 include books, required supplies and equipment and some room and board. For students attending Duke this year, these costs totaled just over $18,000.

529 plan funds can also be used for up to $10,000 per year in tuition for K-12 schools and up to $10,000 in student loan repayments.

Overall, Texas 529 college savings plans offer families a tax-advantaged and flexible way to save for their children's future education expenses. It's never too early to start saving, so consider opening a 529 plan today.