529 savings plan

What is a 529 Savings Plan?

When you’re sticking to a budget, saving for college tuition’s rising costs often gets pushed to the wayside. And when it comes time to look into higher education for your child, you may struggle to obtain the funding needed, which means your child might not be able to access the best available educational options. Luckily, there are better ways to save for college that won’t break your budget. Read on to learn more about 529 savings plans and how they can help.

What is a 529 Savings Plan?

A 529 savings plan is a tax-advantaged savings plan designed to help families put aside money for their children’s future educational needs. These 529 savings plans are usually operated by an educational institution or by the state and were originally established by the IRS in 1996. Their name comes from Section 529 of the Internal Revenue Code. All fifty states and Washington DC operate at least one of the two types of 529 savings plans. There two types of plans are:

  • Prepaid tuition plans – these plans allow you to pre-pay some or all of a college education costs. Typically, the state you live in sponsors these plans and will pay for an in-state public college. There is also a private college 529 plan sponsored by around 250 private colleges and universities and will help pay for a private college education.
  • College savings plans – these types of plans work similarly to a Roth IRA or Roth 401(k) and are run by the state in which you live. To start, a family contributes to these plans that are then invested in mutual funds by a financial expert. This savings plan offers families a few different investment options, and the value will go up and down based on how the investments are performing.

Education planning for your child is essential to give them the best opportunities for the future, so any amount you can put aside now will likely be helpful. Starting to save as early as possible in your child’s life can give them a distinct advantage in higher education and their eventual careers. 

How to Open a 529 Plan

There are a few things you need to consider before you get started with a 529 plan. First, think about which of the two strategies works best for your financial situation and your child’s future. When you choose a prepaid tuition plan, your child will only be able to attend colleges that sponsor the plan. In the case of a state-sponsored plan, your child needs to choose a public, in-state college to take advantage of the plan’s full value. In the case of a private college 529 plan, your child must choose a participating institution. On the other hand, your child can use a college savings plan at any participating university. 

When you’ve chosen which plan is right for you, it’s time to research the options available to you in your state. Each state has at least one option available, but some states have more than one choice available. You should be able to find information about the plan online and begin the enrollment process. To start enrolling, you’ll need your birth date, address, social security number, your banking information, birth date, and social security number of your child, which in this case, is referred to as the beneficiary. 

For some plans, no minimum amount required to start a 529, and you can choose how much you’d like to contribute. Other plans may require a minimum amount to start and minimum contributions. As your contributions build, you’ll likely get a quarterly update about your 529 plan, so you can watch your savings add up. In most cases, a 529 savings plan is capped at between $200,000 and $550,000, which is more than enough to pay for a current college education.

For What can a 529 Plan Be Used?

One of the most significant advantages of 529 plans is that earnings in a 529 plan are not taxed, and you won’t be taxed once you withdraw the funds, as long as they are being used for expenses that qualify. 529 plans are usually used for paying for higher education expenses, including:

  • Tuition and associated fees

  • Books and other materials required for classes

  • Most room and board fees, including meal plans

  • Computers and computer accessories (i.e., keyboard, monitor, mouse, etc.)

  • Some off-campus living expenses like rent, food, and utilities may qualify.

  • Paying back student loans

  • Paying for any additional supplies needed in the case of special-needs students

These plans do not cover costs like entrance exam fees, health insurance for the beneficiary, travel expenses (i.e., gas or airfare), or paying for equipment for clubs or sports. However, as much as $10,000 annually from a 529 plan can be used for tuition at a private, religious or public K-12 school. If you end up saving more than your child needs, you can choose a new beneficiary, i.e., another child, grandchild, or even yourself. If you decide to withdraw money for non-education related expenses, the funds will be subject to state and federal taxes, and you’ll need to pay an additional 10% federal tax.

How Much Should I have Saved for College?

While saving any amount for college is beneficial, you may be wondering if what your saving will be enough, taking into account the rising costs of tuition. Before putting away any funds for college, make sure that you are financially secure enough to do so – ensure that you can pay rent, utility, and grocery bills, and also consider your retirement fund and emergency savings. After those necessities are cared for, it’s also essential to keep in mind that you don’t have to pay your child’s college fund in its entirety. They may secure grants, scholarships, and loans to cover the remainder of the costs. 

You can expect college tuition expenses to rise at least 4% a year with that in mind. You can also predict the return on investment of your contributions based on past performance. While you cannot predict the economy will be in the future, you can make estimates. With this information, you can calculate what college will cost when your child reaches the proper age and how much you can contribute each month to meet your goal. 

 To learn more about saving for your child’s future educational costs, book a call with Elijah Heath, CFP®, ChFC®, CLU®.