529 College Savings Plan – 10 Things to Know

Saving for your child’s education can be challenging. That’s why you should give yourself a head start. A great way to start saving for your child’s future educational expenses is through a 529 College Savings Plan.

What is a 529 College Savings Plan?

A 529 plan is an investing tool that makes it easier to pay for college. Named after Section 529 of the Internal Revenue Code, a 529 savings plan, provides a way to save tax-free for higher education.

The funds can be used at eligible community colleges, trade and vocational schools, universities and graduate schools all across the U.S., and even some abroad.

Grandmas, grandpas, family friends, parents, anyone can contribute to a 529 plan, regardless of income. Contribution limits depend on the state’s plan but are typically more than $200,000.

The federal gift tax exclusion allows a contributor to give up to $15,000 per year per beneficiary, or $30,000 if you’re giving as a married couple.

Furthermore, you could also choose to give up to five years of gifts in one year, and that amount is not considered to be a part of your estate for federal estate tax purposes.

There are two basic types of 529 plans: prepaid tuition plans and college savings plans.

Each state has its own plan and is somewhat unique. States are permitted to offer both types of 529 plans. A qualified education institution can only offer a prepaid tuition type 529 plan.

Benefits of a 529 College Savings Plan

There are several advantages to setting up a 529 savings plan for your child.

  1. All withdrawals are exempt from federal income tax when used for qualified higher education expenses.
  2. All money grows free from federal and state income-tax. Contributions to a 529 plan, however, are not deductible.
  3. Many states also exempt withdrawals from state income-tax for qualified higher education expenses.
  4. You can use the money at an eligible accredited post-secondary institution nationwide, including undergrad, graduate, post-grad, and even vocational, or trade schools.
  5. Money can be used to pay for a variety of college expenses, including tuition, fees, room, board, books, supplies and required equipment.
  6. Up to $10,000 can be used annually to pay for elementary and secondary school tuition.
  7. Anyone who is a U.S. citizen or legal U.S. resident can make contributions, regardless of income.
  8. The account holder retains control of the assets within the program regardless of beneficiary’s age.
  9. Contributions can be made conveniently through payroll deduction or automatic transfers from a bank account.
  10. You can start saving for college right away by choosing low minimum contribution plans.
  11. Many 529 plans are also offered through professional financial advisors who can help you choose a 529 plan and an investment strategy to meet your needs.
  12. Assets within 529 plans are protected from bankruptcy.

Types of 529 plans

As mentioned earlier, there are two main types of 529 plans: the college savings plan and the prepaid tuition plan.

College Savings Plans

College savings plans let a saver open an investment account to save for the beneficiary’s future qualified higher education expenses, like tuition, mandatory fees, and room and board.

The plans are only offered by states, and work much like a Roth 401(k) or Roth IRA. You invest your after-tax contributions in mutual funds or similar investments.

Your plan account will go up or down in value based on the performance of the investment options you choose.

Withdrawals from College Savings Plan accounts can generally be used at any college or university, including sometimes at non-U.S. colleges and universities.

In addition, College savings plans can also be used to pay up to $10,000 per year per beneficiary for tuition at any public, private or religious elementary or secondary school.

Prepaid Tuition Plans

Prepaid tuition plans let a saver or account holder purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and mandatory fees at current prices for the beneficiary.

The main advantage of this plan is that it provides protection against inflation in tuition costs, which has historically been much higher than the general inflation for the economy.

For example, an individual may make prepayments for two future semesters of college at today’s cost. The prepayment guarantees the beneficiary two semesters, regardless of the cost in the future.

Prepaid tuition plans usually cannot be used to pay for future room and board at colleges and universities and do not allow you to prepay for tuition for elementary and secondary schools.

Most prepaid tuition plans are sponsored by state governments and have residency requirements for the saver and/or beneficiary.

Prepaid plans are not guaranteed by the federal government. Some state governments guarantee the money paid into the prepaid tuition plans that they sponsor, but some do not.

If your prepaid tuition payments aren’t guaranteed, you may lose some or all of your money in the plan if the plan’s sponsor has a financial shortfall.

How To Choose a 529 plan

Only you can determine if a 529 plan is a good way to save for your child’s education and which of the two types of plans to select. Setting up a 529 plan is an investment decision, which means both the benefits and drawbacks must be considered.

Also, you may want to consider consulting a trusted tax professional or financial planner to help you through the process.

Here’s what to keep in mind when choosing a 529 college savings plan:

  • In-state tax benefits – such as state tax deductions
  • Investment options – most 529 plans offer a number of investment options, including Age-Based Portfolios, which invest savings based on a beneficiary’s age and the number of years until he or she will be starting college.
  • Fees and expenses – including account management fees and management fees on underlying portfolios
  • Plan performance – when available, review 1-, 3-, 5-, and 10-year performance figures
  • Investment management – what financial services company is managing the plan and what types of services does the company offer?

10 Things to Know about 529 College Savings Plan

1. I am on Low-Income, can I contribute to a 529 Plan?

Anyone can contribute to 529 plans, including low-income individuals and families. Most plans have very low minimum monthly contribution limits making them attractive to families regardless of income level.

Also, most states offer a low-cost plan that can be opened by contacting the plan directly. Some states have minimum limits as low as $15.

2. If I have more than one child, should I have more than one account?

You will likely want separate 529 plan accounts for each child. Each 529 plan account can have only one beneficiary.

In addition, if you plan to take advantage of the Age-Based Portfolio Strategy that adjusts the investments in the account based on the child’s age, you may want separate accounts for children of different ages.

Furthermore, more than one account can be opened on behalf of the same beneficiary.

3. Can I make withdrawals from my 529 plan for tuition at elementary or secondary schools?

Yes. As of 2018, the term “qualified higher education expense” includes up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

4. What If My Child Decides not to go to College?

If the beneficiary of a 529 plan decides not to attend college, the owner can generally change the beneficiary to another eligible family member (out to first cousins).

In addition, you have the option to take out the money as a non-qualified withdrawal, but any earnings on non-qualified distributions are subject to federal income taxes at the recipient’s rate as well as a 10% federal penalty.

5. What happens to money not used in a 529 plan?

If you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:

  • Change the beneficiary to another qualifying family member
  • Hold the funds in the account in case the beneficiary wants to attend grad school later
  • Make yourself the beneficiary and further your own education
  • Roll over the funds to a 529 ABLE account, a savings account specifically for people living with disabilities
  • As of January 1, 2018, parents also have the option to take up to $10,000 in tax-free 529 withdrawals for K-12 tuition

Remember, you can withdraw leftover money in a 529 plan for any reason. However, the earnings portion of a non-qualified withdrawal will be subject to taxes and a penalty, unless you qualify for one of the exceptions listed above.

6. What Do I need to Open a 529 Account?

Opening a 529 account is easy and straightforward. If you are opening an account through a financial institution, you will be required to provide the following information for both the account owner and beneficiary:

As the account owner (the person who owns and manages the account on behalf of the beneficiary), you will be asked to provide the following:

  • Social Security number and date of birth
  • A valid mailing and email addresses
  • Employment information (including company name, address, and start date)
  • General financial information (such as annual income and household net worth)

In addition, the following information will be required for the beneficiary (the beneficiary is the person for whom the Participant is opening the account).

  • A valid mailing address and phone number
  • Social Security number and date of birth
  • General household financial information

Also, when you open the account, you will be asked to select an investment from a range of Investment Portfolios for the account.

7. Am I restricted to my own state’s 529 plan?

No. Your state’s 529 plan may offer incentives to win your business. But the market is competitive and you may find another plan you like more. Be sure to compare the various features of different plans.

8. Can I change the beneficiary of a 529 plan I have set up?

Yes. There are no tax consequences if you change the designated beneficiary to another member of the family.

Also, any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family.

So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty.

9. What is an eligible educational institution?

An eligible educational institution is generally any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education.

Furthermore, beginning in 2018, the term “qualified higher education expense” includes expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

10. Will contributing to a 529 Plan affect eligibility for financial aid?

Yes. Like any savings or investment, assets in the plan are likely to affect your beneficiary’s ability to get financial aid. Federal agencies and schools use complicated and varying formulas to determine financial aid, but your account balance could partially reduce your beneficiary’s determined financial need for these purposes.

If you have any questions about the 529 College Saving Plan, you can ask us in the comments section below.

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