The benefit of attending college can be a valuable one. It is a good time for a person to learn about themselves and their interests. However, the cost of a college education can be high and leave a mountain of debt for years following graduation. Saving for attending college should be part of any financial plan if there is an intention to go to school in the future. This is particularly the case for people that have children. 529 College Savings Plans make saving money for an education attainable.
What is a 529 College Savings Plan?
529 plans were created by Congress in 1996. They are named after the 529 section of the internal revenue code and also referred to as a Qualified Tuition Program. The plans were created in order to help people save for school by allowing savings to grow and earnings to be withdrawn tax-free when used for qualified education expenses.
Normally when investing earnings are subject to taxes when withdrawn. This is not the case for money used from a 529 College Savings Plan. Because money can be invested and used tax-free for qualified educational expenses, it can be an excellent way to save money for college.
529 College Savings Plans are provided within states. But you are not required to use one from the state you reside in. Most states allow residents from other states to participate in their 529 plans. Plans can be used not only for qualified college expenses but also tuition at elementary or secondary schools. Up to $10,000 could be allowed for some K-12 costs.
What are the Advantages of Using a 529 College Savings Plan?
• There may be state tax benefits if you invest in your own state’s 529 plan. If for example, a state offers a 10k tax deduction for investing in their state plan, you may be able to deduct that amount from your state taxes if 10k is invested in a year. A tax professional should be consulted to see if this is something you may have available.
• Anyone can set up a 529 plan and there is no limit to the number of plans that can be established. You could start a plan for yourself as the beneficiary. A plan could also be set up for a friend or relative.
• There are no income restrictions as a contributor to a 529 plan.
• 529 College Savings Plans can be transferred to other family members. If you don’t have any children today, but plan on having a few in a couple of years, you could open a 529 plan and then transfer it to one of the children. This has the advantage of planning early.
In addition, there is no date or deadline the money in a plan needs to be used. If a beneficiary does not attend college, the plan could just be moved to another family member as the beneficiary.
• Control of a 529 College Savings Plan is by who purchases the plan. They are the custodian of it and have control until the money is taken out. This is good for parents that want to ensure the money is used for its intended purpose, which is education.
• There are no annual limits on contributions to a 529 College Savings Plan. However, there are maximum overall limits. This will depend on the state and their plan. For example, a plan might have an overall contribution limit of $200,000. This would be the maximum amount allowed to be contributed to the plan. A person could contribute $0 or up to a $200,000 contribution in one year as long as the maximum contributions do not go over the lifetime limit.
Are there Disadvantages to 529 College Savings Plans?
• If money is withdrawn from a plan and not used for qualified education expenses, the earnings will be taxed and a 10% penalty will apply.
• Just like any investment 529 College Savings Plans could lose money. However, they typically offer more conservative investments and are designed for long-term investing.
• Certain 529’s may have limited investments.
• Fees could be high depending on the provider and if it is a broker sold plan or direct one.
• A 529 College Savings Plan could potentially have an impact on federal student aid. This will depend on the situation.
• With an owner of a 529, such as a grandparent, distributions could be considered as untaxed student income. This could potentially reduce student aid significantly.
• There could be tax issues if a person contributes more to a beneficiary 529 plan that allowed for the year’s gift tax.
Should You Start a 529 College Savings Plan?
The cost of higher education is not going to start decreasing anytime soon. The price for going to college does not have to be a lifetime burden of student loans with proper planning and an adequate investment time frame.
Just like any other type of long-term investment, planning early can make the difference between having enough money for a goal and falling short. The issue with saving for college is many wait until the last minute to prepare. A 529 College Savings Plan is not right for everyone. However, it should be something to consider for just about anyone that has plans to go to college. Starting a plan will depend on each individual’s situation and goals.
It can be easy to put saving for education to the side thinking scholarships or student aid will take care of things. This may be the case, but it will rarely pay for everything. There will be some expenses that won’t be covered.
Saving for a college education does not have to be difficult and just a little saved each month can make a big difference in ten or fifteen years. Maybe there will not be enough to pay for four years of school, but there might be enough for two. This could mean the difference of having a lifetime of student loans and just a few years to pay back.
Not Saving Because It Might Hurt Financial Aid Eligibility is Not the Answer
Although a 529 College Savings Plan can affect financial aid eligibility, the truth is that most mid-income families have a challenging time qualifying for a lot of free aid. Figuring student aid has an EFC (Expected Family Contribution) and there is a certain amount that is not subject to being included in calculating financial aid. For a family that has saved some money, but not a large amount, the money saved may not even be included. A family’s taxed and untaxed income, as well as their assets, are figured into EFC. The lower a score the more aid that may be available.
If a student does not qualify for much free aid, it likely will not be just because there is a 529 plan. There are many calculations that go into getting federal student aid and not saving something for college is not going to help if there are other factors that could hinder the outcome.
I can remember when I was enrolled in school paying my own expenses for tuition through loans and working to pay rent and buy food. I did not qualify for financial aid. Rent was something I could barely afford. I was told I made too much money. Qualifying for full free aid is not likely in almost all situations. Something will have to be paid to go to school.
There are lots of good scholarships available, but believing that a full-ride one will be offered is not likely for most. They are scarce. Likely if a student is excellent in school or sports a full tuition only or part tuition scholarship may be offered. There will still be some expenses at some point.
The excuse that school will be paid for is not a good answer for not saving. This is not known until the commitment is in hand, which by then it could be too late to save.
Applying for scholarships should be part of acquiring money to go to school, but they should not be completely depended on.
You Will Not Have to Pay Taxes and Penalties on Everything if a 529 Plan is Not Used
One of the misconceptions about 529 plans is if the money is not used it will either be lost or all of it will be taxed and penalized. This is not the case. The original contributions made to a 529 will not be penalized. It is only the earnings. If you were to contribute for example $18,000 to a plan and it grew to $30,000, taxes and penalties would only apply to $12,000 if the account was closed out and not used for qualified educational expenses.
How Do You Find a Good 529 College Savings Plan?
Just because a state has a 529 plan they offer does not necessarily mean you should invest in that one. Research, research and then research some more. Picking one will depend on a number of factors including any state tax benefits, fees, and investment options.
If a state you live in offers a 529 plan that has state tax benefits, consult with a tax professional to ensure you can benefit from investing in the plan. Not all states have an in-state tax and this will not apply to everyone.
Fees are a big part of any investment including 529 plans. Perform plan comparisons and their fees. Websites, such as Savingforcollege.com, have some great tools for making comparisons. Direct 529 plans will often have lower fees than a comparable broker-sold plan. However, a lot of plans have indexes that can be used to invest or age-based investment portfolios. In my opinion, I prefer a direct 529 plan opposed to one broker sold. Broker plans may even have a sales charge in addition to higher fees. High fees and sales comissions cut into returns over time. With education costs as high as they are every penny will count. Here is a previous article available on things to consider when looking for mutual funds. If you are more comfortable with a broker sold 529 plan, there is nothing wrong with this, but it is important to know the costs may be higher.
What is the Conclusion on Starting a College 529 Plan?
My view on saving money for college is that something is better than nothing. According to collegesavings.org the average 529 plan only has $24,153 as of June 2018. This is far from four year’s worth of tuition at most state universities. Yet, people are saving something with the College Savings Plan Network claiming one-third of Americans have a 529 College Savings Plan. This is good news to see that people are planning. However, many are still not looking at the long-term picture.
Student debt seems to be getting worse as the expenses for education keep rising. Whether you are planning for a relative, yourself or children to attend college, you need to save. Saving early and saving as often as possible is the answer to at least try and limit the amount of student debt upon graduation. Not having student loans is the best, but having ten thousand dollars in debt is better than thirty or forty.
For people that have children, start saving early. A hundred dollars a month or even fifty can go a long way at regular investment intervals of the same amount. Circumstances change and more money may be able to be put into a plan later or less may need to be contributed. But not starting something should not be a choice.
A college degree does not automatically equal success and not everyone ends up graduating. Things in life happen. Saving for college in a 529 plan or even just saving early altogether can make a world of difference by not having student loans or at least limiting the amount borrowed. Not being in debt creates opportunity and choices. Graduating with no debt or very little gives a student the best chance for succeeding.