Everything You Need to Know About a 529
From the moment you become a parent, chances are financial fears set in. And fast.
Regardless of your financial situation, one large cost begins to hang over your head from infancy — how the heck will we afford college tuition?
Try not to let this overwhelm you, though. Thankfully, there are some cost-effective savings options when it comes to paying for college — the most popular being a 529.
We spoke with financial experts to find out everything you need to know about this savings plan, the pros and cons, and anything else that may help you navigate the murky waters of financial planning.
What is it, exactly?
Essentially, a “529” comes with two options — college savings plans and prepaid tuition plans. Logan Allec, a CPA, personal finance expert, and owner of personal finance blog Money Done Right explains that “both are directed at being able to save money in a tax-advantaged way in order to apply that money towards education.”
The 529 plan is offered by the state, not the federal government. Depending on which state’s plan you select, the plan may vary a bit. It’s also important to know you don’t have to choose the state based on where you live, either.
Education Savings Plans
An education savings plan allows you to invest after-tax money into an account that will then grow tax-free and can be withdrawn to pay for qualifying education expenses. This includes tuition, books, room and board, etc. Essentially, you put your money in after it’s been taxed, but when you withdraw it, you don’t pay taxes.
Typically, the money you deposit is held in generic investment funds as it grows.
Prepaid Tuition Plans
A prepaid plan operates differently, allowing an individual to buy credit for a specific college or university in advance. Allec says, “For example, a parent can pay for credit for a semester at a college while their child is still in middle school. Then, once the kid gets to college, a semester is already paid for.”
Who Should Open One, and When?
As with most savings strategies, the sooner you can start — the better.
Allec explains that the key users of a 529 plan are typically parents as they save for their children’s future education expenses. He says, “ Whether in funding the entirety of their child’s education or just chipping in, all parents who will help with college should use a 529.” A 529 allows parents to save money in the most efficient way possible. “Regardless of the amount, saving in a tax-advantaged manner is always the best strategy!”
Ideally, if you plan to help contribute to your child’s education, Allec suggests opening an account as soon as they are born because “the money will have time to compound and grow within the account for as long as possible.”
However, he offers another important piece of advice that is perhaps best discussed with your personal financial professional. Allec warns, “I would only recommend contribution to a 529 plan after you have your own retirement savings on track.”
Of course, various savings and investment plans come with their own sets of pros and cons. A 529 is no different. As for the pros, there are numerous, but perhaps most important is tax-free growth. Allec says, “The big advantage of a 529 plan is the ability to use tax-advantaged income in order to save for education. With college tuition rising quickly, every extra dollar you can save without taxes can go a long way to pay for college.”
Next, there are state tax benefits depending on where you live. Currently, over two dozen states offer either a state income tax deduction or credit based on the amount contributed to a 529 plan.
Many may not know that technically a 529 is not limited to colleges or universities. Funds from a 529 can also be used for continuing education or trade school. And, he explains that “the Tax Cuts & Jobs Act made it possible for 529 funds to be used to cover up to $10,000 per student per year for private elementary, middle, and high school tuition.”
One of the biggest drawbacks of a 529 plan is that often, 529 deposits end up going unused because not every child will need to use the funds for education. When you don’t use them, you can not simply withdraw the money without penalty.“If non-education-related withdrawals are made, you will pay not only income taxes on the gains associated with the distribution but also a 10% penalty on the gains as well,” Allec explains. If you find yourself in that situation in the future, you do have options. Allec says you can wait it out and continue to let the money grow in the hopes your child may pursue an education in the future, transfer the plan to another qualifying family member, or make yourself the beneficiary and use for your own educational endeavors such as an advanced degree or continuing education. Another “con” is that within a 529 plan, there is limited ability to direct your own investments. For example, Allec says, “Let’s imagine your 529 plan investments only make a 5% return a year. However, you find that the ETFs in your retirement accounts return 8% a year. You cannot direct your 529 plan to invest in those ETFs without withdrawing the money, which would be subject to the fees and taxes mentioned above.”
The Bottom Line
Whether a 529 investment plan is right for you and your family is a personal decision, but it is one of the most popular strategies in securing some financial stability for future education expenses. According to the College Savings Plan Network, the average 529 college savings plan balance hit a record high as of last summer, meaning more and more people are opening and investing in these types of accounts.
Before making any major financial moves, it is always recommended to speak to your personal financial expert.
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