What is a 529 Plan? How to Save for College

College can be expensive. For the 2018-2019 academic year, the average cost to attend an in-state four-year public institution was $21,370, and it was $48,510 to attend a four-year private institution. College tuition has been rising almost six percent above the rate of inflation, and is expected to continue rising. Thinking about how to pay for your child’s college education can be a headache but rest assured, you’re not alone. A 529 plan may assuage many of your concerns about financing college, so continue reading to learn more.

What is 529 Plan?

A 529 plan is a tax-advantaged college savings plan. The name 529 comes from Section 529 of the Internal Revenue Code, which authorizes what are legally known as “qualified tuition plans”. Essentially every state has at least one 529 plan and certain private colleges and universities have others. That being said, you can invest anywhere–you do not have to invest in your state’s 529 plan. 

How Does the Plan Work?

There are two types of 529 plans: education savings plans, and prepaid tuition plans.

Savings plans allow you to open an investment account to save for your child’s future qualified education expenses, including tuition, room and board, books, and mandatory fees. Funds from education savings plan accounts can generally be used at any college or university, occasionally including non-U.S. colleges and universities. With education savings plans, you have the opportunity to invest in various mutual funds. Most plans offer age-based asset-allocation options, meaning that as your child approaches expected college age, the investments will gradually become more conservative.

In contrast, prepaid tuition plans allows you to prepay parts of or all of the tuition of a designated college or university at the current price. The costs will not be influenced by inflation, so with this plan, you can guarantee your child the number of semesters equivalent to the amount you have prepaid at that particular institution. Note that prepaid tuition plans can’t be used for room and board, and can only be applied towards predetermined, eligible institutions.

When it comes to time to withdraw from your 529 plan, you have the options of sending payments to the educational institution, the beneficiary (usually your child), or the account holder.

Different plans have different requirements, restrictions, and policies. It can be confusing to navigate it all, but financial advisors can help you make an informed decision.

What are the Benefits of a 529 Plan?

Aside from the obvious benefit of security that comes with a dedicated and rewarding college savings plan, another main benefit can be found in tax advantages.

While not deductible, earnings put into 529 plans aren’t subject to state or federal tax as they grow. Unlike other savings vehicles like mutual funds, a 529 plan wont be taxed at withdrawal as long as they are used for qualified educational expenses—if not, withdrawals are subject to taxes and a general 10% fee. Although contributing to a 529 plan won’t reduce your taxable income, many states provide tax deductions or credits for contributions in a 529 plan. 

Another reason to invest in a 529 plan is its convenience. Once you select a 529 plan and make a contribution or authorize automatic deposits, the investment will be taken care of by the plan, requiring no intervention on your side. That being said, the donor has full rights to the account, ensuring that the money will be used as intended without creating hassle regarding maintenance. 

What do Parents Need to Know?

Though 529 plans can be extended towards graduate school, you may find yourself in a situation where there are excess funds even after your student has completed their desired coursework. In these cases, the beneficiary can be changed to another family member, including yourself.

A 529 plan is also flexible in other ways. If your financial situation changes rapidly and demands new strategies for saving, a 529 plan will allow you to adjust your investment options up to two times each year.

Having money set aside for a student’s college education inevitably affects his or her qualification for need-based financial aid. In considering financial aid packages awarded, different colleges and universities have different policies with regards to 529 plans. In general, though, savings in 529 plans are considered to be part of your family’s assets, and will therefore reduce the amount of need-based aid your child qualifies for. A 529 plan will not, however, impact your child’s eligibility for merit-aid, which is often another means to receive additional funding for college.

If your family is thinking of starting a 529 plan for your child, the best tip is to start early. When it comes to saving for college, it’s never too early.

Does your teen want access to expert college guidance — for free? When they create their free CollegeVine account, they will find out their real admissions chances, build a best-fit school list, learn how to improve their profile, and get their questions answered by experts and peers—all for free. Encourage them to sign up for their CollegeVine account today to get a boost on their college journey.