What Is a 529 College Savings Plan?

Time to start saving for a loved one’s college tuition? 529 college saving plans are one of the most popular ways to save for college and K-12 tuition. They have a wide array of benefits, but perhaps the most notable is that they offer tax-free earnings growth and tax-free withdrawals when the funds are used to pay for qualified education expenses. 

In this article, we’ll go deeper into the benefits of 529 college saving plans. We’ll also discuss how to access those funds when the time is right.

More About 529 College Savings Plan

529 college saving plans can be used to pay for college across the nation. Most states offer at least one 529 plan, so you should research their features and benefits carefully before investing.

As mentioned, the money in these accounts can be withdrawn tax-free as long as that money is spent on qualified withdrawals. The list of qualified education expenses includes:

• Tuition
• Fees
• Books
• Supplies
• Equipment
• Technology

In certain situations, you may be able to use your 529 plan to pay for room and board.

You won’t be charged any taxes on withdrawals used for qualified education expenses.”

You can also make tax-free withdrawals of up to $10,000 per year per beneficiary to pay for tuition expenses at K-12 schools. These tax-free distributions may also be used to repay federal and private student loans.

With a 529 plan, you can still take your money out of the account at any time, but you will be taxed on anything you withdraw that is not used for those qualified education expenses. That means income taxes and a 10% tax penalty. 

There are some costs that you may deem necessary that the IRS does not, so be sure you’re aware of what falls under the qualified education expenses category. Common expenses that may fall outside this category include health insurance and transportation costs.

Benefits of 529 College Savings Plans

There is a reason 529 plans are so popular – they have a wide array of benefits and are a great vehicle for saving the money needed to send your kids to school. The tax benefits are the most notable, but there are plenty of benefits beyond that too.

Tax benefits

Here are the primary tax benefits associated with a 529 college savings plan.

• Tax deductions. Most states let you deduct your 529 plan contributions when you file your federal income tax return, which means lower taxes for you.
• Tax-deferred growth. Unlike a taxable account, your earnings in a 529 plan will be deferred from federal and usually state taxes.
• Tax-free withdrawals. Perhaps the best benefit – you won’t be charged any taxes on withdrawals used for qualified education expenses.
• Gift tax benefits. If you or someone else wants to make a large contribution as a gift, there are tax benefits- up to 5 years’ worth of contributions can be made at one time without triggering a gift tax.

Other benefits

Tax benefits are not the only reasons to consider a 529 plan. Here are some of the other reasons to consider opening an account for your loved one.

• You control the account. Unlike simply putting your own money into an account that you will hand over to your child, you control this account and where it is spent, even when the child is an adult.
• You can save as much as you want. You can increase your education savings by contributing as much money as you want- the maximum amounts are pretty lofty, usually between $300,000 and $500,000 per beneficiary.
• Save for anyone. You are not limited to saving for your children. You can save for a grandchild, other family members, friends, or even yourself.
• Have less counted against you in financial aid scholarship discussions. Other forms of savings may limit your child’s access to financial aid. With a 529 plan, as long as you are the account owner and your child is your dependent, you see a much smaller impact on financial aid decisions.
• Potentially grow your money. Most plans allow you to choose from a portfolio of investment options, like stocks and bonds, so that your savings can grow.
• Have access to the money if you need it. You can still withdraw the money and use it if there is an emergency, even if you won’t be spending it on qualified education expenses. The catch is that you will have to pay some taxes on what you withdraw.

Opening a 529 College Savings Plan

You know all the benefits of opening a 529 plan account, but how do you go about actually opening one? It is actually a pretty simple process. 

Choose your plan

The first step is doing your research and deciding which plan is right for you. First, you need to choose between a savings and a prepaid plan. 

• Savings plans act like 401ks, giving your savings a chance to grow before you need them. You will have several investment options to choose from, and the account will go up and down in value based on the performance of those investment options. 
• Prepaid plans allow you to prepay the cost of a college education. These plans are generally limited to in-state colleges but may sometimes be converted for private or out-of-state colleges.

You also need to decide if you want to choose an in-state or out-of-state plan. If you have a state tax benefit, it is likely in your best interest to stay in-state. You can see what your state tax benefit is worth with this calculator from Vanguard.

Choose your beneficiary of beneficiaries

Remember, you are not limited to your children in selecting the plan’s beneficiaries. You can save for other family members, friends, yourself, and even an unborn child. You do, however, need to gather information to select the beneficiary.

Make sure you collect the date of birth and social security number for your future student. Many plans have age-based target options, so it is good to open an individual account for each child.

Open the account and build the portfolios

Most accounts can be opened online. Once the account is open, you can begin to deposit money into it directly. If you have opted to go with a savings plan, you can customize your savings options. 

Many people opt for an age-based portfolio that corresponds to the age of the beneficiary. Much like a 401k savings account, this is a diversified account that will become more conservative as the beneficiary reaches college age. You can also build your own investment mix.

Final Thoughts

No matter what you choose, you need to understand that 529 plans will fluctuate with the market and do not have guaranteed returns. There is even a small chance that you may lose a part of your principal. If you want to avoid that completely, it may be best to go with a prepaid plan. That said, there is a high potential for growth with 529 plan accounts, and they wouldn’t be so popular if most people lost money with them.

You must also know that with a 529 plan account, you are only allowed to make investment changes twice in a calendar year. This applies only to funds already deposited, so if you want to move money from plan portfolios A & B to plan portfolios C & D, for example, you can only do so twice a year. You generally have an unlimited say in how your future contributions will be invested.