Saving for College – What is a 529 Plan?

The cost of college is one of the biggest expenses most Americans face. Average annual tuition at a four-year public college in the U.S. is currently $9,410 for in-state students and $22,890 for out-of-state students, with the average at a four-year private college standing at $32,410 a year. If you are looking at college in the future for yourself or a loved one, a 529 college savings plan could be the way to go. These college savings plans offer tax and financial aid benefits for people who want to save for the cost of going to school. As of 2017, only about 20% of parents were saving for the cost of their child’s college education, but statistics show that children are four times more likely to go to college and graduate if their parents have made saving for it a priority. It isn’t the amount saved that drives this statistic, either – it can be as little as $500 or even less – it’s the example set by having any sort of college savings account that shows your kids that continuing education is important.

What is a 529 plan? A 529 plan is an educational savings plan that is exempt from federal taxes. It is legally known as the Qualified Tuition Plan but called after section 529 of the IRS tax code. Plan contributions are made from after-tax dollars, and earnings from investments accumulate on a tax-deferred basis. 529 college savings plans offer families who are saving for college several tax and financial aid benefits. These plans also offer tax advantages at the state level in most states with a state income tax. 529 plans are not limited to saving just for college; they can also be used to finance K-12 education and post-graduate studies.

The Two Kinds of 529 Plans. There are two types of 529 savings plans available, a college savings plan and a prepaid tuition plan. A prepaid tuition plan has time limits for withdrawals, and some costs such as room and board are not covered. These plans lock in the current cost of tuition and may be offered directly through the college or university of your choice. By pre-paying tuition, these plans can potentially save you a lot of money, since tuition costs continue to soar year after year. College savings plans are investment plans structured like a Roth IRA and managed by a program manager. Contributions are invested in mutual funds and stocks, and there are no time limits for withdrawals. Plan fees typically include an account maintenance fee, which pays the manager for administrative costs, an advisor fee if you choose to work with one to help manage your plan, and a total asset fee, which is based on the success of your portfolio. Any state income tax credit you receive can help offset the cost of these fees, and your state may waive certain fees.

How Much Can You Contribute to a 529 Plan? The funds in your 529 plan or plans are considered gifts, and the IRS has not set a specific annual contribution limit, but there are some rules you’ll want to keep in mind. When it comes to setting up your 529 plan, the initial start-up amount is often as little as $25. Once the plan is in place, further contributions are optional. You contribute as much and as often as you like, whether you use monthly bank drafts, make occasional lump sum contributions, or divert a portion or all your annual tax returns. And although only one person can be the beneficiary of each account, more than one person can make contributions. For 2019, contributions may total up to $15,000 per plan, per individual to qualify for the yearly tax exemption.

How Can a 529 Plan be Used? Tax-free withdrawals of up to $10,000 per year are allowed for qualifying educational expenses. If a withdrawal is made that is not used for a qualifying expense, it is subject to both taxes and penalties. You will need to report all withdrawals on your annual tax returns, regardless of how the funds are used. Qualifying educational expenses include:

• Tuition costs
• Books and supplies
• Lab fees and equipment
• Computers and internet fees
• Room and board for on-campus students. Cost cannot exceed what the college charges.
• Rent for off-campus students. Check with the school’s financial aid office for cost figures. This is considered a qualifying expense if the student living off campus is enrolled at least half-time.
• K-12 tuition. 529 plans can also be used for private elementary and high school as of 2018. Parents can withdraw up to $10,000 per student annually for tuition alone.

The cost of health insurance, transportation, and student loan payments are considered non-qualifying expenses, and withdrawals made for these purposes will be subject to income taxes and result in a 10% penalty.

What if the Beneficiary Doesn’t Use the Plan? If your child does not attend school, receives a full ride scholarship and doesn’t need the plan funds, or is selected to attend a U.S. Military Academy, there are several options which enable you to avoid taxes or penalties:

• Keep the account intact for the named beneficiary to use at a later date
• Maintain funds in the plan for graduate school
• Change the named beneficiary to another family member
• You can name yourself as beneficiary and attend school
• Funds can be transferred into a 529 ABLE account

Setting up a 529 plan makes good financial sense for a lot of reasons. Saving money always costs less than borrowing it and is much less painful in the long run. Remember the statistic we quoted earlier? Your children are four times more likely to go to college and graduate if you make saving for it a priority. Knowing you have invested in your child’s future helps inspire and motivate them to do the same, so choose a 529 plan option today that works with your budget and start investing in higher education for your children…or yourself!