How 529 College Savings Plans can pay for your degree?
529 College Savings Plans are a personal favorite of mine. My parents set up one for me when I was younger and truly helps when it came time to pay for college. If you have some spare cash at the end of every month and are looking at possible options and ways to proactively save and invest for your child’s tuition, then 529 plans may be an option for you.
Challenging will all the information out there to know what’s right and in an effort for risk aversion is may give us that not-so-popular paralysis by analysis.
Let’s take a slice of knowledge pie and see what they are, how they work and how having a 529 can help you with paying for your child’s college.
What is 529 College Savings Plan?
A 529 saving plan (also known as a 529 college fund) is defined simply as a college savings plan.
529 plans offer both tax and financial aid benefits.
There are two types:
- College savings plan
- Prepaid tuition plan
Almost every state has at least one 529 plan.
History of the 529 plan
529 college savings plans were actually created under a Small Business Job Protection Act of 1996. This allowed taxpayers a tax-advantaged way to say for higher education and designate a beneficiary. They are provided by states or agencies of the state. The name comes from Section 529 of the Internal Revenue Code.
How 529 College Saving Plans Work?
The 529 college fund let’s a person grow savings on behalf of a beneficiary. This “recipient” can be a child, grandchild, spouse, and even yourself.
The plans have an account owner who controls the investments and therefore selects the person deemed as the beneficiary.
The money invested in these plan are tax deferred and the distributions are tax-free.
Now there is an expansive definition of “qualified” higher education expenses and those are:
- Tuition Fees
- Books and Supplies
- Computers and Internet Access
- Room and Board
- Special Needs Equipment
The funds are 100% yours in a 529 plan. You can withdraw them at any time for any purpose. Please keep in mind that they are going to be subjected to income taxes and potential penalties.
The funds also grow federal tax-free and will not be taxed when the money is used for the “qualified” education expenses.
529 College Plan and Prepaid Tuition Plans
Both the 529 college plan and a prepaid tuition plan help with the cost of college for your child.
They often get confused but each type of plan offers tax advantages intended for college.
What is the different between the College Savings Plan and the Prepaid Tuition Plans?
College Savings Plan are similar to Roth 401k’s or Roth IRA’s. The 529 will present several investment options from which to choose and they will go up and down and all around based on the performance of the options.
Prepaid Tuition Plans – The meaning is in the name. This plan lets you pre-pay part or all of the costs of an in state public college. Eventually it can be converted to a private or out of state college.
529 Plan Benefits
It’s important to note the 529 plans benefits as it’s really an appealing factor when looking to invest in college.
The benefits are:
- Income tax breaks
- Your own state may offer tax breaks as well
- You stay in control of the account
- Low Maintenance – It’s very hands-off. You just let it ride and set it and forget it.
- Simple tax reporting – No 1099 here
- Flexibility – You can make changes twice per year
- Everyone is eligible for this plan
What if child doesn’t use the plan?
A very common question when researching a 520 college savings plan is: What happens if my child doesn’t use the 529 plan?
If your child doesn’t go to college or in an absolute fantastic scenario your child gets a scholarship then generally there is an income tax or a penalty. However, the way to avoid paying taxes is to:
- Change the beneficiary (i.e. another child)
- Hold the funds in the account for your child’s graduate school
- Make yourself the beneficiary and continue your education
Disadvantages of 529 plans
So far so good right? Everything sounds amazing. Well, just like with anything in life there are drawbacks and disadvantages. Let’ see what some disadvantages of the 529 plans are below:
- Upfront costs – Depending on certain state plans there may be a minimum contribution requirement.
- The money must be used for college – This goes without saying but you will be penalized if you withdraw the money to use it on something other than an educational expense.
- It could have impacts on your financial aid eligibility – As of now it doesn’t affect your eligibility as its considered part of the parents assets. However, changes to the rules are always occurring.
- Investment options are limited – The plan manager is selected by your state. This limits the control one has. You can only change how you’re allocating your plans balance twice a year.
- Penalties for ill-timed withdrawals – There are certain rules and even limits for how much you can withdraw in a year. This could lead to you being subjected to the IRS gift tax. Consult with your advisor before taking any action.
529 Plan Rules
With the benefits and disadvantages of the 529 savings plan, there are also rules. These rules mostly have to do with the fact that the savings plan gets tax advantages.
Here are the important rules that you need to know:
529 college savings plan are state-sponsored
As mentioned earlier, the 529 plans are managed by the state. You don’t have to invest in your own state’s plan. Now some states will offer additional benefits for investing in your states plan so make sure you are doing your research.
Beneficiary does not have ownership
The beneficiary does not have control over the funds. Everything is funneled through the account holder. They have complete power and are in control.
No set contribution limits
Unlike the Roth IRA’s and traditional IRA’s, 529 college savings plans do not have specific limits established by the IRS. High contributions may trigger a gift tax so as always proceed with caution.
Strict qualified distribution rules
If your child (or whoever the beneficiary is) happens to receive a scholarship, you can withdraw funds equal to the amount awarded. Those earnings are subject to taxes but at the very least there is no additional penalty.
529 College Plan Fees
Are there fees associated with the 529 plan?
Depends on how they are purchased. If purchased through as advisor then you would have to check with them to see what types of fees are associated with buying the plan though them. You get their expertise and advice which is a plus.
The direct-sold plans (taking the advisor out of the equation) should only be subjected to the annual fees of the state. They are purchased directly from the plan manager. You will have to rely on your own research to identify your best options.
529 Plans by State
We are not limited to investing in state’s plan that we live in. Some states may have lower fees and perform better.
For example, I have a New York 529 plan for my children and I live in Florida. My cousin who lives in New Jersey has his children enrolled in a Michigan 529 plan.
One of my favorite tools you can access here: 529 College Savings Plan Comparison. Simply select what state places you what to compare and you can see the differences.
The main differences you will see with be minimum and maximum contributions, major plans fees, and state income tax benefits.
Best 529 Plans
Not all 529 college savings plans are the same. Some of them are better than others due to the lower fees and better investment choices.
Every state has at least one 529 plan. Some even have two or more.
A good way to see if one 529 college savings plan is superior over the others is to look at:
- Investment options
- Management expenses
- Past performance
Top 529 Plans
Let’s look at some of the best rated and top 529 plans that are currently available.
Plans available: 17
Maximum contributions: $0
Total maximum contribution $520,000
Pros: High maximum investment, various investment options, low fees
Cons: State income tax deduction, rollovers can be subject to tax
Plans available: 20
Maximum contributions: $25
Total maximum contribution $462,000
Pros: Many portfolio types, low expense ratios, conservative and high-performing investments
Cons: State income tax deduction
Plans available: 16
Maximum contributions: $25
Total maximum contribution $511,758
Pros: Healthy performance history, secure savings options, low management expenses
Cons: State income tax deduction
A handy tool that I think everyone should play around with is a 529 Plan college savings calculator. The one I personally like to use can be found here: College Savings Calculator.
You can place in your child’s name, the state you are in, and what grade they are presently ion. Then select the type of college and you can see what you savings goal will need to be and how much per month would be recommended to contribute.
Now don’t get too alarmed because the monthly contribution amounts may be high. Remember this is a piece of the puzzle.
529 Contribution Limits
Unlike an IRA or 401(k) plan, there are no contribution limits for 529 plans. There are maximum aggregate limits. These limits vary by state plan.
The federal law states that 529 plan balances cannot exceed cost of the beneficiary’s qualified higher education expenses. These limits can range anywhere between $235,000 to $529,000.
If one where to go over the limits, the funds can remain in the account without penalty, but the family (or owner of the account) will not be able to make future contributions unless there is a market drop.
529 Tax Deductions
We have mentioned 401(k)’s as a comparison to the 529 savings plan so you can see how they differ.
Anyway they differ is that you cannot get federal 529 tax deductions for your contributions to your account. Even though you can’t write them off on your federal income tax return, you might be able to do so on your state tax return.
More than 30 states (plus Washington D.C) offer a 529 tax deduction or credit which allows you to write off your 529 contributions. This will in return lower your tax burden.
Deductions of course vary by state and more are more than others.
Compare 529 Plans
The comparing of 529 plans can be overwhelming. Ensure you are checking the expense ratios, which tell you how much it costs to run the plans—and how much will be taken away from your earnings to do it.
Smaller plans, such as those in North Dakota and Arkansas, have fewer investors and a smaller asset basis, so management fees tend to be higher.
Some plans are superior and better than others. The performance of these states plans relies on their ability to move. Those that do not evolve are the ones that eventually will fall behind.
How to Open a 529 College Saving Plan?
After all of this talk about 529 plans, if you wanted to pursue one how would you open it?
Here are the steps:
- Choose a 529 Plan – Either with your state or a state’s plan that you have researched
- Complete the 529 plan application – It’s pretty
simple to enroll online. Note that you will need the following:
- Name of the owner
- Name of the beneficiary
- Personal information about the account owner and beneficiary (address, telephone number, email address, date of birth, social security number).
- Fund the 529 college savings plan
- Choose investments
You can also open up a 529 college savings plan with a financial advisor (like I did). Please note the fees will be different but for me personally I like using their expertise and talking with someone about the investments. I can also call on them to add more money if need be.
The best way to save for college?
So is the 529 college savings plan the best way to save for your child’s college? I think it’s one of the better ways for sure.
It’s interesting because only 21% of families in the Unites States are currently using college 529 plans.
The only reason that I can think of is lack of knowledge or just not information out there. Maybe the fact that each state has a plan adds to the confusion? Whatever the case is, there is opportunity for parents to use a 529 college savings plan for their child.
My advice on 529 college plans is that if you are really serious about looking into one for your child, do your own research and consult with a trusted financial advisor. You do not have to go with the state plan in your state and do not be overwhelmed by the suggested contribution amounts. You can chip away at this and add a little here and there. It will help your child for sure….trust me!!!
Again to summarize, I would suggest the following as your next and actionable steps:
- Research several state’s plans
- Narrow down your search
- Crunch the numbers
- Look the fees and past performance history
- Either enroll online or through a financial advisor
Tuition Drop Podcast
Check out our episode below of the Tuition Drop Podcast of 529 College Savings Plans.