What You Need to Know about 529 College Savings Plans

Freshly-graduated, college-bound high school seniors have their whole lives ahead of them when they throw their caps in the air. The last thing on their mind is how they’re going to pay for the education, nor how long it will take them to pay off that education. Since 2008, costs have increased by around 25.3% for private colleges (to $48,510) and 29.8% for public colleges (to $21,720). No recent graduate is really ready for that kind of debt!

But this is where you can help—at least if you plan ahead. College Savings Funds are a helpful tool that will allow you to set aside money for your children’s education (and benefit your tax bill) all while earning interest! Let’s take a look at why this might be a path you want to take.

WHAT ARE THE OPTIONS FOR COLLEGE SAVINGS PLANS?

When it comes to options for college savings plans, there are a few paths you can take. 

  1. You can stash cash under your mattress. We’ll assume you see that this isn’t the best idea.
  2. You can use a normal savings account and rack up that .6% APY.
  3. You can take advantage of a 529 Plan. They come in two varieties: prepaid tuition plans and college savings plans

Let’s look at the 529 plan more closely.

PREPAID TUITION PLAN

With a prepaid tuition plan, you (the ‘contributor’) deposits money in advance to cover all or a portion of in-state, public college education costs. If your child chooses to go to an out-of-state or private university, you can convert the sum towards their tuition, but with a penalty. You are effectively pre-paying tuition to your state’s higher educational institutions before their tuition and fees increase.

529 COLLEGE SAVINGS PLAN

With a 529 College Savings Plan, your contributions are after federal tax and grow interest-free (similar to a Roth IRA), going into something like a mutual fund—the investment vehicle varies from state to state. Your investments, then, gain or lose value depending on the investment’s performance. Many states (beyond the federal tax-free benefit) will also provide tax relief—i.e. you may be able to receive a tax deduction or credit for your 529 contributions.

Each state offers its own plans, but you can choose to invest in any state’s 529 plan depending on what you’re wanting to get out of it—some offer better benefits than others. You can choose to have your 529 in, let’s say, New Jersey, but you can use the funds to attend college anywhere without penalty.

Because the type of plan you ultimately select has a lot of factors (e.g. your financial circumstances, personal budget considerations, etc.), you may have a difficult time determining which type of 529 plan to choose. If you do have questions or are considering which direction to go, don’t hesitate to reach out and ask for help. We can help you determine which plan, and which state, offers the best benefit for you and your family. 

WHAT YOU NEED TO KNOW ABOUT 529 COLLEGE SAVINGS PLANS

WHAT CAN A 529 COLLEGE SAVINGS PLAN BE USED FOR?

To avoid federal tax on earnings, you have to use the money for qualified educational expenses. That includes tuition, room and board, books, computers, and internet access. If you use 529 funds for non-qualified expenses, you may be required to pay federal income taxes on any earnings withdrawn, as well as a 10% federal penalty tax, and possibly state and local taxes.

WHO SHOULD OPEN THE 529 COLLEGE SAVINGS PLAN?

Whoever opens the 529 plan owns the plan. That can be a parent, grandparent, or even the student themselves. Remembering that all invested funds must be used for the beneficiary’s qualified educational expenses, you’ll want to be sure that the money you invest will be able to be used properly (or face the tax penalties mentioned above).

While grandparents can open a plan for their grandchildren (and doing so would allow more time, potentially, for interest to accrue), you’ll want to think through the financial aid implications that will bring further down the road. The FAFSA (Free Application for Federal Student Aid) form takes into consideration the 529 contributions of parents, but not of grandparents. So, if the student draws from the 529 that a grandparent has set up, it may adversely affect their ability to apply for federal student loans.

Again, if we can help you think through the tax-implications of a 529 plan, give us a call.

HOW TO SET UP A 529 PLAN

It’s relatively easy to set up a 529 plan. Here are the steps to take: 

  1. Select a College Savings Plan. This will likely be the hardest part. You need to determine which type of 529 plan you would like (prepaid tuition or college savings plan) and then in which state you’d like to open it. You can use a site like savingforcollege.com to help you compare and contrast the various options available to you. And don’t stress—there are a lot of good options to choose from.
  2. Gather the documentation. You’ll need all the personal information necessary to open the account. Check out the chosen plan’s website to see what they’ll require.
  3. Open the account. You can usually do this online, though some states may require you to mail in the application.
  4. Choose your investments. There are various options for how you want your funds to be invested. We can help you look at the benefits of the investment plans and help you choose the best one for your beneficiary. But don’t fret—you can make up to two changes per year if you see that you’d rather go a different investment route.
  5. Deposit Funds. This is the easy part? Yes, it’s easy. Simply do an online transfer or mail in a check. It’s that easy to invest in your child (or grandchild’s) future education!

If you run into any roadblocks (or if this all sounds like rocket science), please know that we are here to help you! We can take a look at all the options with you and help you put together a plan that will both benefit your tax situation and the education of your family. You can call us at (888) 272-7102 or write us here.

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Aug 5, 2020
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