Saving up money for college is a significant stressor for many parents and young adults. While the cost of a college education and the prospect of not having enough for loan repayment is daunting, there are avenues for college savings plans with numerous tax benefits to help you prepare.
For instance, a 529 savings plan is a popular option for many parents and students looking to invest in college education in a way that suits their personal and financial needs. This plan has numerous tax advantages that may suit your situation. You’re in luck if you’re seeking a better way to save for a college education. This article will dive deep into a 529 college savings plan and explore everything you should know when opening a college savings account.
What is a 529 College Savings Plan?
A 529 college savings plan is offered in 49 states and the District of Columbia, with Wyoming being the only state without a 529 option. The plan is designed to help parents and other family members save for future college costs. 529 plan is a tax-advantaged savings plan that offers tax benefits for both the contributor and the beneficiary.
The 529 college savings plan is devised to encourage account holders to save for their education costs. These plans are legally known as qualified tuition plans and are sponsored by the state, state agencies, or specific educational institutions. While they are often mistaken for mutual funds, 529 plans differ in significant ways. Additionally, a 529 college savings plan allows the account holder to withdraw funds tax-free to cover various college expenses and might include state or federal tax benefits.
A 529 college savings plan will help you save for a college education in more ways than one. For instance, this savings plan can contribute to your education in some of the following ways:
- The beneficiary is not disqualified from receiving federal financial aid if they have a 529 savings account, meaning they can save even more.
- Anyone over 18 can fund their continuing education with a 529 plan.
- Account holders can make tax-free withdrawals for eligible expenses.
- The plan has a low minimum contribution amount.
- If the student receives a scholarship for their education, the amount of the scholarship award can be withdrawn from the 529 plan without additional federal income taxes on their earnings.
What are the Types of 529 College Plans?
There are two types of 529 plans: prepaid tuition and savings plans. While tax-advantaged savings plans are the most common type of 529 plan, prepaid options might suit your situation. Below is an overview of both types of 529 college savings plans to help you make an educated decision.
- Prepaid tuition plans: Prepaid 529 plans allow the account owner to pay for tuition in advance and additional fees and expenses. With a prepaid plan, you pay in advance for all or part of an in-state public school tuition and lock in the tuition when you make your payment.
- A 529 college savings plan is more common than a prepaid plan. With these plans, investments grow tax-free, and the student can withdraw funds tax-free to cover education expenses, including textbooks, tuition, and room and board.
Which Plan is Better?
Ultimately, both types of 529 college savings plans have benefits, and you should base your decision on your specific circumstances. While you should conduct your due diligence to ensure that you’re choosing the right plan, some indicators could help guide you in the right direction.
For example, prepaid 529 plans are a wise option for individuals under the following conditions:
- Those who are sure of where their child or the beneficiary will attend college
- Those that want to avoid potential increases in tuition costs that they might not be able to afford down the line
- Those that aren’t looking to invest their education savings
- Those that want the lowest-risk option
However, a 529 college savings plan might be better for individuals with the following circumstances:
- Those who want to save for college but aren’t sure where their child or beneficiary will attend
- Those who want to invest in a more flexible plan than a prepaid option; for instance, if a beneficiary decides not to pursue college, the account holder can transfer funds to a different beneficiary. The option to transfer leftover funds in a 529 is a significant benefit of this option.
- Those looking to make a low minimum contribution to the plan
How to Open a 529 College Savings Plan
Opening a 529 plan is a smart way to save for college expenses and can help you make the most of your college savings goals. Here’s what you need to know about opening a 529 plan.
1. Research Your Options
The first step in opening a 529 plan is to research your options. Different states and institutions offer different 529 plans, and each one has different features and fees. When researching 529 plans, pay attention to fees, investment options, and tax benefits. Look for plans that offer low fees, a variety of attractive tax benefits, and investment options saved in a 529 plan.
2. Choose an Account Beneficiary
Once you’ve chosen a 529 plan, you’ll need to select an account beneficiary. The account beneficiary is the person who will benefit from the 529 plan, and the account beneficiary can be yourself, your child, or another family member. When selecting an account beneficiary, consider the person’s age and whether they will likely use the money for college expenses.
3. Set Up an Account
After selecting an account beneficiary, you’ll need to set up an account. Depending on the 529 plan, you may be able to set up an account online, or you may need to complete a paper application. When setting up an account, you’ll need to provide the beneficiary’s name and Social Security number and your own name and Social Security number. You’ll also need to provide information about your finances and income.
4. Make Contributions
Once you have opened an account, you can contribute to your 529 savings plan. Contributions can be made in cash or checks or be made electronically. When making contributions, you’ll need to provide the beneficiary’s name, account number, and the amount you’d like to contribute.
5. Invest the Funds
Following your initial contribution to the account, you’ll need to invest the funds. Depending on the 529 plan, you may be able to choose your investments, or you may need to select from a predetermined list of investments.
When investing the funds, consider the beneficiary’s age and how much time is left until college. If the beneficiary is young and you are in a secure financial position, consider riskier investments that can offer more long-term growth potential.
6. Monitor Your Account
After opening and funding your account, it’s essential to monitor it regularly. 529 savings plans are subject to market fluctuations, fees, and other factors, and keeping an eye on performance is essential. You can monitor your account online or contact the 529 plan provider and request a performance report.
7. Withdraw Funds
When it comes time to pay for college, you’ll need to withdraw funds from your 529 plan. Depending on your 529 plan, you may be able to do this online, or you may need to contact the provider and request a withdrawal. When withdrawing funds, use the money for qualified educational expenses. You’ll be subject to taxes and penalties if you use the funds for non-qualified expenses.
What Should I Consider Before Opening a 529 Savings Account?
When you open a 529 plan account, there are a few considerations to remember throughout the process. Below is a breakdown of everything to consider before you open your 529 savings account for yourself, your child, or another beneficiary.
1. Consider How Much You Can Afford to Contribute
Before opening an account, consider how much you can contribute to a 529 plan. According to the plan, there are no annual contribution limits for 529 plans. However, investments in a 529 plan are considered complete gifts for federal tax purposes, and after a specific limit, contributions must be reported on your IRS Form 709.
In 2023, contributions up to $17,000 per donor and beneficiary will qualify for an annual gift tax exclusion; however, beyond this, contributions count against your gift tax exemption number.
2. Research Your State’s 529 Plan
Each state offers its own 529 plan, so you should research and compare the different available plans. Each state has its rules and regulations, so make sure you understand the plan before making a decision.
For instance, many states don’t require investors to be a resident when opening an account, and some states may offer additional benefits to individuals that are residents of a specific state. Know your state income tax and ensure you have all the knowledge you need to make an informed choice.
3. Consider the Fees and Expenses
Fees and expenses vary from plan to plan, so ensure you understand the fees associated with your chosen plan. Some plans may have account maintenance fees, investment management fees, or other administrative fees that can impact your earnings. Additionally, some 529 college savings plans require a specific initial investment that you should prepare to pay in advance.
4. Know the Tax Implications
Contributions to a 529 plan may be tax-deductible in some states, and federal tax credits may be available. However, it would be best to understand the tax implications of the plan you choose before you make a decision. Most 529 plans allow investors to defer their federal taxes, but state-level tax benefits often vary depending on where you reside.
5. Decide Who Will Manage the Account
A 529 plan is an account held in the name of a designated beneficiary, so it’s important to consider who will manage the account. The owner could be you, the parent, or another adult designated by you.
6. Understand Withdrawal Rules
Withdrawals from a 529 plan can be tax-free if used for qualified education expenses. However, there are rules and regulations regarding withdrawals, so make sure you understand them before you make any withdrawals.
What are My Other Options?
If you decide that a 529 college savings plan isn’t for you, there is no need to worry–there are other options for saving for college. Consider the following options if you aren’t sold on a 529 savings plan.
1. Free Application for Federal Student Aid (FAFSA)
An alternative option to a 529 savings account is the Free Application for Federal Student Aid (FAFSA). This form is used to apply for federal student loan apprenticeship programs and helps determine your eligibility for federal grants, loans, work-study programs, and other educational assistance. However, remember that a 529 savings plan does not disqualify you or your child from receiving federal student aid.
2. Coverdell Plans
Another way to save for college is by considering a Coverdell ESA. This option is similar to 529 plans and allows you to save for your child’s education before they are 18. These plans can help cover primary and secondary expenses, including education expenses. However, Coverdell ESA plans only allow the account holder to contribute $2,000 per year, and not everyone can open one of these accounts.
If you haven’t considered scholarships, now is the time. As you or your child prepares to begin higher education, you can explore a variety of scholarships that are worth your while. While nothing is guaranteed, it never hurts to try this option when getting ready for college.
This guide to 529 accounts should help you make the best decisions for saving for college. Before making a final decision, ensure that you know everything about the different types of 529 plans and alternative options that might be available to you, depending on your situation. With careful planning, you can guarantee that you or your child have the necessary funds for higher education and a prosperous future.
If you’re looking for ways to save and plan for your future, whether it’s for education or retirement, we’re here to help. Save Plan Retire has the information you need to save for your future and live comfortably. With our guidance, saving for college won’t feel complicated or overwhelming. Look to our expert advice to get started on building your future.