The 529 savings plan helps make affording college slightly easier as your child enters his/her college years.
Saving for college doesn’t have to be overwhelming. When you start early and possibly even include others, such as family members, it’s possible to have a decent amount saved when your child goes to college. Whether your child is a baby or is already in the formative teen years, it’s important to understand the 529 plan and how it works.
What is the 529 Plan?
A 529 plan is like a retirement account, but for a college education. You contribute the money after-tax, but your earnings grow tax-free. If you withdraw the funds for qualified education expenses, the earnings remain tax-free. If you withdraw the funds for reasons other than education, though, you’ll pay taxes according to your tax bracket plus a 10% penalty, so be careful.
Each state has at least one and sometimes more 529 plan options which may be one of the following:
- 529 College Savings Plan – You contribute money like you would a retirement account. The money is invested in mutual funds and the value will increase and decrease over time.
- 529 Prepaid Tuition Plan – You purchase tuition now, long before your child needs it. You pay today’s rates, but your child uses it in the future. You must choose a specific school for this plan, unlike the savings plan, which you can use country-wide based on your child’s decisions when it’s time to choose a college.
How to Pick the Best 529 Savings Plan
Most people choose a 529 plan in their own state, but you can choose a plan outside of your state too. If your state doesn’t offer enough benefits (tax write-offs) or charges high fees, you may opt for an out-of-state plan.
If you do choose an out-of-state plan, it’s best to look for those that offer out-of-state tax benefits. In other words, you still get a tax write-off for using the plan. A few of the top states that offer out-of-state tax benefits include:
- Arizona offers single files a $2,000 tax write-off and joint filers $4,000
- Kansas offers single filers a $3,000 tax write-off and joint filers $6,000
- Missouri offers single filers an $8,000 tax write-off and joint filers $16,000
- Pennsylvania offers single filers a $15,000 tax write-off and joint-filers $30,000
Pros of the 529 Plan
The 529 plan has many benefits, including:
- Tax-free growth – You’d be hard-pressed to find any other way to invest your money where the earnings grow tax-free and that you can withdraw funds without paying taxes. While retirement accounts do offer this option – you only get the tax benefit in retirement, not when your child goes to college.
- No limitations – There isn’t a federal limit you must follow as far as contributions. You can contribute as much as you want each year; however, you may be restricted by the federal gift tax, which is $15,000 in 2020.
- You can shop around to find the best plan – You aren’t limited to your state’s offering. If you like the way another state’s plan invests the money or your state doesn’t have attractive tax write-offs, you can choose a different state’s plan.
- You may be able to use the funds for K-12 education – The Tax Cuts and Jobs Act made it possible to use the funds for any education, not just college. You may use up to $10,000 on K-12 expenses.
- You have flexibility with the funds – If one child decides not to go to college, you can roll the funds over into another child’s 529 plan or even change the beneficiaries
- Anyone can contribute – If you choose to share that your child has a 529 plan, relatives and others can contribute to it. This is a great way to get meaningful birthday and holiday presents that truly help your child in the future.
Cons of the 529 Plan
As with everything else, there’s always a ‘downside’ to things too. The 529 plan downsides include:
- Hefty taxes and penalties if you don’t pay for college – If you don’t use the funds to pay for qualified expenses, whether it’s due to your child not attending college or any other reason, it could cost you a hefty fine
- Some state plans have minimum investment requirements – Depending on the state plan that you choose, you may be held to strict investment requirements, which could mean hefty upfront costs. You may also have to meet minimum monthly requirements.
- It may affect your financial aid – As a part of the financial aid package, the Department of Education looks at the family’s financial abilities, which includes any 529 savings plans. The presence of a college savings plan could increase your Expected Family Contribution and decrease the amount of aid you receive.
- You have little control over the investments – When you choose a 529 plan, you choose the investment plan put together by the state. If you prefer to have complete control over your investments, you may be disappointed.
Contributing to a 529 savings plan can be a great way to save for college, but use caution. Because the penalties are so high if you withdraw funds for other reasons, you don’t want to tie up money you may need down the road. Invest your money carefully and even involve the assistance of family members that want to help too. Anyone can contribute to your child’s plan, helping to decrease the number and amount of loans your child must take when he/she goes to college.
