College has become extremely expensive. Tuition rates increase every year, as does the cost of room and board, books, and class fees. There are so many expenses involved with going to college that it’s hard to keep track of them all.
However, many people will do what it takes to send the ones they love, whether that’s their children, nieces or nephews, or grandchildren, to continue school past the age of 18. One fantastic option for saving for college is a 529 plan. Take a look at everything you need to know about this important financial tool.
What Is a 529 Plan?
At its most basic level, a 529 plan is a savings account that can be used to help a student pay for college (or possibly an apprenticeship) and that has certain tax benefits. There are two types of 529 plans: prepaid tuition plans and education savings plans.
Prepaid Tuition Plans
With a prepaid tuition plan, a saver or account holder can purchase units or credits at participating colleges and universities. These units or credits are locked in at their current price at the time of purchase. Then, they can be used to pay for future tuition and mandatory fees when the beneficiary attends the college.
This type of 529 plan can only be used to pay for tuition and mandatory fees – not room and board.
Prepaid tuition plans are usually available for public and in-state colleges and universities. It’s important to know that if the beneficiary of the plan does not attend a participating college or university, then the prepaid tuition plan may pay out less funds. Pay close attention to the details of the 529 offering circular if you are looking for flexibility.
Education Savings Plans
The second option is an education savings plan. With this type of 529 plan, a saver or account holder can open an investment account to save for the beneficiary’s future qualified higher education expenses.
Those qualified higher education expenses include tuition, mandatory fees, and room and board as well (unlike prepaid tuition plans). It’s fantastic that the funds saved in this type of plan can be used for such a variety of education-related expenses. Plus, education savings plans can be used at almost any college or university in the United States and even at some outside the country.
According to the Securities and Exchange Commission, “Education savings plans can also be used to pay up to $10,000 per year per beneficiary for tuition at any public, private or religious elementary or secondary school.” So if you’re interested in sending your child to an elementary or secondary school with fees, an education savings plan may be the best choice for you.
What Goes Into These Investments?
Like retirement and other savings accounts, there are different approaches that you can take to a 529 plan. You can choose between exchange-traded fund (ETF) and mutual fund portfolios, which are usually combined with a principal-protected bank account.
As with many other types of investments, there will be fees to pay on a 529 savings plan.
Factors that Affect Fees
There are three factors that will affect the fees associated with a 529 savings plan. These are:
- if the plan is broker-sold or direct-sold
- the type of plan and its underlying investments
- if it is an education savings plan or prepaid tuition plan
Fees to Expect
Unfortunately, as with other types of investments, 529 plans do have fees. Prepaid tuition plans may charge either an enrollment fee or an application fee. They will possibly charge administrative fees on a continuing basis as well.
Education savings plans have more fees than prepaid tuition plans. The state sponsor will collect some fees, and the plan manager will collect others. These fees include an enrollment or application fee, ongoing asset management fees, ongoing program management fees, and annual account maintenance fees.
If you purchase a broker-sold education savings plan, then it will be subject to additional fees as well. Fortunately, many states do offer direct-sold education plans, so you can avoid paying the extra broker fees by choosing a plan from the state.
Are These Plans Guaranteed by the Government?
The federal government does not guarantee prepaid tuition plans. So, while you can purchase units or credits at participating colleges and universities, they are not guaranteed if something disastrous were to happen to the market. However, some state governments guarantee the money paid into prepaid tuition plans.
While all education savings plans are sponsored by state governments, they do not guarantee investments in these plans. However, there are many benefits to investing in a 529 savings plan, including the fact that they are protected from bankruptcy. Check out a full list of benefits here.
Where Can You Set Up a 529 Plan?
Here’s some good news – all 50 states and Washington, D.C., sponsor at least one type of 529 plan!
What Is an Offering Circular?
An offering circular is, essentially, a very detailed document that includes information about how a 529 plan is funded. It’s also called a disclosure statement, program description, or offering document. Thoroughly read the offering circular before agreeing to the 529 plan or speak with a tax accountant or adviser about it.
529 Plans and Taxes
Each state has its own laws regarding the taxing of 529 plans. You may want to speak with a tax adviser before you choose a 529 plan.
Typically, if you contribute to a 529 plan, then you should be able to deduct your contributions from your state income tax. It’s also more likely that you’ll see tax benefits if you contribute to a 529 plan sponsored by the state where you live. However, there are restrictions, which is why it can be helpful to work with a tax adviser.
It’s extremely important to use your 529 savings plan funds only on educational expenses. When you do, you will likely be exempt from paying state income tax and federal income tax on those funds. But if you don’t, then you’ll not only be taxed on your withdrawals, but you’ll also most likely also have to pay a 10% federal tax penalty on the earnings. Avoid being fined – only use the 529 plan funds on education-related expenses!
529 Plans and Financial Aid
For many students, going to college wouldn’t be possible without the help of financial aid. That’s why it’s important to know exactly how a 529 plan will affect a student’s ability to receive financial aid.
The fact is that a college or university may offer a student less in scholarships or in loans if they have a 529 plan. However, it’s preferable to have the money in savings than to take out loans. When you consider the amount of interest that you’ll pay over time, it’s clear that saving in advance is the financially-savvy way to go.
The Changes of 2019
There were two major changes made to how 529 plans work in the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The first change is that the act now allows 529 plan distributions of up to $10,000 to repay qualified student loans of the beneficiary. There is also a provision for repayment of student loans for siblings. The $10,000 cap is for the lifetime of the plan, and it’s the same for siblings.
The second change is that now 529 plans can be used to pay for registered apprenticeship programs. So if there’s a student in your life who isn’t interested in college, but is curious about an apprenticeship, then you may want to find out if your 529 plan can be used for an apprenticeship program.
The College Savings Plan Network
Several tools can help you find the best 529 plan for your family. One is the College Savings Plan Network (CSPN), which was founded in 1991. According to the organization, the CSPN “serves as a clearinghouse for information among state-administered college savings programs. Additionally, CSPN monitors federal activities and promotes legislation that will positively affect Section 529 plans.”
The CSPN emphasizes that college tuition rates have been increasing at two to three times the rate of inflation each year. That makes saving for college and sending kids to it extremely difficult for parents. However, a 529 plan can make it easier to save for college.
It’s important to be smart and efficient about how you save for a 529 plan. Determine how much you can afford to save, and then set up automatic transfers for your savings. Then, decide which 529 plan you want to choose.
It’s a good idea to start by looking at your state’s plan. Use this tool from the CSPN to find out more information specific to your state. Then you can compare your state’s plans with others that offer the features you’re looking for.
Always Consult First
Before you sign the dotted line on any major investment, it’s important to seek advice from a professional. The same is true of 529 savings plans. While it’s impossible to predict the market, it is possible to vet out the best 529 plan for your family. Talk to at least one professional before you decide to invest, and remember that the earlier you can start saving for college, the better!