With National College Savings Day (which is 5/29, coincidence, we think not) right around the corner, we wanted to talk about one of the most popular education savings vehicles available to you: a 529 plan.
A 529 plan has been used by parents and students alike to help save for the massive cost of education today. Depending on if a college is private, public, in-state, or out-of-state, students could pay upwards of $50,000 per year for an education! With that number in mind, finding another savings option may not sound like such a bad idea.
Let’s get down to it— what is a 529 plan and how does it work? How can you best use them in your financial plan? The answers may surprise you.
What exactly is a 529 plan?
A 529 plan is a tax-advantaged savings vehicle designed to help save for the cost of education. Though initially limited for a college education only, 529 plans have since expanded to include K-12 education through to graduate programs.
There are two types of 529 plans: education savings plans and prepaid tuition plans.
The most popular 529 plan is an education savings plan. An education savings plan allows you to contribute after-tax dollars into an investment account to save for the beneficiary’s future. The monetary gains grow tax-free and the distributions remain tax-free as long as they go toward qualified educational expenses such as tuition, fees, room and board, and books.
These savings can also be used toward elementary and secondary schools. However, you may have to consider riskier investment opportunities if you wish to use the funds in that way. This is because you will have less time to save for elementary education versus college education.
While not the most popular, prepaid tuition plans can be an excellent option for some people. Prepaid tuition plans are only offered by certain states and can allow the account holder to pay for all or a portion of tuition and fees in advance in order to lock in a current rate.
There are also more restrictions with prepaid tuition plans including:
- A limited number of universities accept them.
- Prepaid tuition plans cannot go towards room, board, and/or books.
- These plans are not guaranteed by the federal government.
- You cannot use these plans for elementary or secondary schools.
A major benefit of 529 plans is that anyone can open an account— no matter your income. While they are most commonly set up by parents or grandparents to help fund the education expenses of someone in their family, that is certainly not the only available route to take.
529 plans are executed on a state by state basis, so it is important to know the different rules for your specific area. This can be tricky for family members who live in a different state, but you are not limited to using a plan from your home state. For example, you can live in California and contribute to a 529 plan in Ohio.
Now that you know the basics of both education savings plans and prepaid tuition, it’s time to learn about the tax advantages that await you.
Tax advantages of 529 plans
In general, 529 plans were created to be tax-efficient. As long as the withdrawals are made for a qualifying educational expense (room, board, books, ect.), it will not be taxed. If you have to withdraw the money for any other reason, you will have to pay ordinary income tax and be subject to a 10% penalty.
As we said above, even though each state operates its own 529 plan, you aren’t restricted to opening a 529 plan in your home state. However, by opening an account in a different state you may possibly forego some credits or deductions. For example, California’s plan Scholar Share doesn’t offer state exemptions or credits.
There aren’t typically any annual contribution limits on 529 plans like there are with a 401(k) or IRA, but that goes on a state by state basis. However, there is usually a lifetime limit, which for California is $475,000.
The bottom line is that the longer your money is invested, the more time you have for the funds to grow and the tax benefits to be greater.
How to best use a 529 plan
Of course, the primary purpose of a 529 plan is to save for future educational expenses. While this is the most effective way to use your money, it can be used in other ways.
The SECURE Act allows for $10,000 from 529 plans to be used to pay toward student loan repayment of the beneficiary and the beneficiary’s siblings. This is a lifetime limit with no tax consequences.
There’s also a chance that your child may not attend school after you’ve invested in a 529 plan. In this case, you can transfer the plan to another beneficiary if you have multiple children, transfer the fund to another family member, or use the funds for your own education.
This may not come as a surprise, but the earlier you get started with your savings, the better the outcome will be. We’ve said this in all areas of the financial process, but with the cost of education rising every year, it’s vital to put money away as early as possible.
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Saving for education expenses can be one of the largest savings ventures a family can face. With the cost of education continuing to rise, the emphasis on saving, and saving early, can put you and your family in a good position to remain financially stable throughout the whole process.
Every state has its own 529 plan and whether you choose an educational saving or prepaid tuition plan, it’s important to think about what is most important to you in a plan and how you can set your family up for a bright future.
Our advisors at Platt Wealth Management are here to help you use your money in a way that not only enhances your life but the lives of others around you. Take control of your future education and give us a call at (619) 255-9554 or email us here for a review of your finances, on the house.