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A 529 savings plan is designed to make it easier to save for higher education at every level, from undergraduate school to a graduate program and beyond. As long as your institution and expenses are eligible, you can enjoy the tax benefits of a 529 plan while also reducing your reliance on student loans for graduate school.
What is a 529 savings plan?
A 529 plan is a tax-advantaged education savings plan. Originally, these accounts were designed to cover only postsecondary education costs, but now you can also use them for K-12 education and apprenticeship programs. You can also use a 529 plan for graduate school.
The money you contribute to a 529 plan is federally tax-deferred, meaning your earnings can grow without the burden of taxes. Eligible withdrawals from this kind of account are also tax-free.
Additionally, many states offer either a tax deduction or tax credit for those who contribute to a 529 plan, making it even more attractive for parents who want to save for their children’s education. For example, the state of Indiana offers a 20 percent tax credit (up to $1,000) for contributions made to a 529 savings plan within a calendar year.
That said, there are strict requirements to maintain the tax-free status of your contributions and withdrawals.
Using your 529 savings plan for graduate school
While many parents use a 529 savings plan to cover a student’s undergraduate education, 529 plans can also be used to help pay for a graduate degree. If you’re thinking of using a 529 plan for graduate school, here are some things to keep in mind.
Eligible financial institutions
In order to use your 529 savings plan funds for your graduate studies, you must attend an eligible educational institution. In general, that includes any college, university, vocational school or other postsecondary institution that’s eligible to participate in the U.S. Department of Education’s student aid program.
This includes most graduate and professional schools in the U.S., as well as some foreign educational institutions. So whether you’re going to medical school, dental school or business school, the chances are high that you’ll be able to use your 529 plan funds.
Your school should be eligible if it’s on the Department of Education’s database of accredited postsecondary institutions and programs.
A 529 savings plan can be used to pay for qualified education expenses. According to the IRS, that includes tuition, fees and other related expenses incurred by:
- You or your spouse if you file a joint tax return.
- A student you claim as a dependent.
- A third party, including relatives and friends, named as the plan’s beneficiary.
Beyond tuition and fees paid directly to an accredited institution, other expenses can include:
- Room and board (if you’re enrolled on at least a half-time basis).
- Computer-related expenses.
- Special needs expenses.
If you withdraw money for ineligible expenses, the earnings portion of the withdrawal will be taxed as ordinary income and you’ll be subject to a 10 percent penalty. You won’t pay the tax or penalty on your account contributions, because that money has already been taxed by the government. But you will be responsible for paying taxes on any investment earnings you’ve earned on the account.
If this applies to you, your account servicer should issue a 1099-Q form for tax-filing purposes.
One exception to this rule: If the student receives a scholarship, they or their parents can withdraw up to the amount of the scholarship and use that money without penalty. You will, however, need to pay income taxes on the portion of the withdrawal attributed to investment gains.
What are the drawbacks of using a 529 plan for graduate school?
One downside of a 529 savings plan is that it’s an investment, which means that there’s volatility. If you invest the money in a 529 plan in stocks or mutual funds so your savings can grow over time, you face the potential of losing money in your account in the near term.
This risk is especially important to consider if you’re saving for graduate school at the last minute. After all, investments are never guaranteed to show a positive return, but that’s especially true over timelines of a few years or less. If you’re putting money into a 529 plan that you may need soon, the possibility of seeing your account balance drop should be on your radar.
Also be aware that money in a 529 plan can impact your eligibility for financial aid, and that 529 funds in your own name have a greater impact on aid eligibility than those held by a parent for their child. 529 assets must be claimed on the Federal Application for Federal Student Aid form (FAFSA), which will impact eligibility for loans, grants, and other funding.
Who should use a 529 plan for graduate school?
The main benefit of 529 savings plans is the fact that money can grow tax-free, and distributions are tax-free when they are used to cover eligible higher education expenses.
If you live in a state that offers tax benefits for contributions made to a 529 savings plan, using one can help to lower your tax burden while making it easier to cover college expenses.
In general, 529 plans for graduate school make the most sense if:
- You’re a high earner who is looking for ways to maximize tax advantages.
- You have money left over in a 529 plan after paying for undergraduate education.
- You started saving early.
The bottom line
Using a 529 savings plan for graduate school can make it easier to afford your degree and reduce the student loans you need. Before you invest in one of these accounts, it’s important to understand both the drawbacks and benefits of 529 plans, how to maximize their value and how to avoid penalties.
Additionally, you may also want to consider other education savings plans, such as a Coverdell education savings account or a Roth IRA. As you shop around and compare your options, being well-informed will put you in a position to pick the best one for you.