529 Savings Plans: An Online Guide for College Students
From understanding the basics to opening your account, learn the advantages of a 529 college savings plan, take away expert advice, and get started saving today.
Matt Hylland is a partner and financial planner at Arnold and Mote Wealth Management in Cedar Rapids, Iowa, a fiduciary, fee-only investment advisor. Matt specializes in comprehensive, holistic financial planning that incorporates not only investments, but estate, tax, and education planning as well. Matt has been featured in The Wall Street Journal, CNBC, Kiplinger, and other nationally recognized finance publications.
It’s easy to sweat when crunching the numbers. Between 1989 and 2016, the cost of college in the U.S. increased eight times faster than the average yearly wage. And while this uneven growth can make the most financially responsible parents stress over the thought of tuition, saving for college is still more than manageable.
Opening a 529 savings plan can be a smart way to take advantage of tax benefits while simultaneously growing a college fund. Families that start a 529 plan when their children are young can benefit from enormous tax savings and significant earning on their investments over time. Provided you use the money on education-related expenses, the 529 plan can be hard to beat, especially for families with more than one kid. To learn more about the advantages and benefits of a 529 plan and to see how it stacks up against your other college savings options, keep reading.
How 529 Plans Work
529 plans are state-run tax-advantaged savings plans that were originally designed for prospective college students and their families to help save tuition money. The plan works by contributors putting funds into an account that are invested in various ways such as in bonds and stocks. After the money grows over time, the account owner removes the money for the beneficiary’s education expenses.
There are two types of 529 plans: one where you simply accrue money in a savings account, and one where you buy college credits or units. The educational savings plan functions more like a traditional savings account and is intended to help you cover the cost of tuition and fees, school technology expenses, books, and room and board. The prepaid tuition plans allow you to buy units or credits at those schools that participate in this program at their present-day prices and avoid some inflated tuition costs in the future.
Anyone can open a 529 plan, including parents, guardians, and family members of the student beneficiary, and any of those people can contribute money to the savings account. In 2019, the plan was expanded to include K-12 expenses as well, making it an even more appealing plan. Today, 34 states offer state income tax deductions on contributions to these 529 plans, ultimately saving the contributor money on their taxes each year. In fact, when you follow the guidelines and use the money for educational expenses, the money is tax-free.
How a 529 Plan Stacks Up
Advantages of 529 College Savings Plans
Anyone can contribute to the plan
Grandparents, parents, relatives, and the student themselves can put money in the pot. Anyone contributing to a 529 plan can claim the appropriate deductions on their state income taxes. The amount of tax benefits you receive depends on where you live and how much money you’ve contributed to a 529 plan during the year.
The 529 plan can be changed without penalty to another beneficiary as long as the new individual is a relative
This may be a good thing for parents and guardians who aren’t sure if their intended beneficiary is going to go to college after all. Should the prospective student become a successful rock star or entrepreneur before freshman year, for example, the plan can be assigned to someone else who will go to college or vocational school. As long as there is a beneficiary listed on the account, it can remain open.
When used for education expenses, the money you take out of the account will be tax-free.
Up to $10,000 per year from a savings plan can be used for tuition and expenses at private and public institutions
Beginning in late 2019, the government also authorizes 529 money to be used to pay back the beneficiary’s student loans, or their siblings’ student loans, up to $10,000.
Tax-free growth and tax-free withdrawals
There are a wide range of investment options for 529 savings plans, including mutual funds and the stock market. The great thing about 529s is that the money that’s made in those accounts can grow each year without being subject to federal income taxes.
4 Steps to Opening Your 529 Plan
Now that you know a bit about how the 529 plan can work for you, what does the process of opening the account look like? Here’s a list of steps that can take you where you need to be and make sure you’re covering your bases in the process.
Pick a State
If you’re choosing to invest in a prepaid tuition plan, you’ll probably need to choose the plan for the state where you live. 529 education savings plans, on the other hand, do not necessarily require you to open an account in your state of residence. Since you’re looking for the excellent state income tax benefits, it’s smart to look at the other state plans with promising investment options and low costs and fees.
Submit Your Application
You’ll fill out an application online or submit a hard copy through the mail. Most applications require you to include the necessary banking information as well as your and the beneficiary’s social security numbers, mailing addresses, and birth dates. Usually there’s only one owner per 529 plan, even for married couples. The beneficiary can be anyone, including your child, a relative, a friend, or yourself.
Pick a Successor
In the event that you pass away or become incapacitated in some way, you will need to have someone on file to manage the account. This may not be a requirement in all 529 applications, but it is certainly a good idea to have someone prepared to take it over if necessary.
At this point in the process, you will have to pay any necessary upfront fees, like an application fee, and make a payment toward the plan. Some 529 plans require a minimal contribution upfront when you set up the account. Once the account is officially open, any of your friends or family can make a contribution. This can often be carried out using an online bank transfer or mailing in a check. The state where you have your plan may have some restrictions on how much money can go into the 529 account. Most recently, the federal government required that gift tax be paid on individual contributions above $15,000 per beneficiary.
Things to Keep in Mind About 529s
Like any type of financial investment, there’s going to be some things to keep an eye on, including the types of risks you’re taking. Additionally, there are some general guidelines and stipulations to expect with 529 plans that need to be considered in order to get the most out of your investment. Here’s a list of important things to remember.
- When funds are withdrawn, they must be used for education expenses such as room and board, tuition and fees, books, and necessary technology expenses. If it turns out that the beneficiary wants the funds and will not use them for college purposes, or for tuition at a secondary or elementary school, they will pay taxes on the account’s earnings in addition to a 10% penalty fee.
- Fees and general underlying costs can affect your overall earnings in a 529 account. The types of fees and costs you’ll incur depend on which state your account is located in and if you have a plan through a financial advisor. Secondly, you may take on additional costs for the types of investments that are made with the money in the account, such as mutual funds. There may also be annual fixed-amount account maintenance fees.
- Unlike some other plans out there, in most cases, the beneficiary does not have legal rights to the funds in a 529 account. The donor stays in control of the money in the account.
- Tax benefits vary among states and you’ll need to keep a close eye on how your location affects your potential tax savings. Most states require you to be funding an in-state plan while others offer income tax breaks for you regardless of whether or not you invest in a 529 sponsored by the state you live in.
- There may be restrictions and guidelines for your investments in a 529 savings plan. Due to the current tax law, you can only make changes to investment options up to twice per year or when you change the account to a different beneficiary.
- Students with prepaid tuition plans can only use those units or credits at colleges and universities that participate in the program.
- The money held in a 529 account may affect a beneficiary’s eligibility to receive need-based financial aid for college.