Who Can Benefit From 529 Plans and How To Decide If They’re Right For You
A 529 Plan is an education savings plan designed to help families set aside funds for future college costs. These tax-advantaged savings plans have big benefits for families planning for their children’s futures, yet most Americans don’t take advantage of this savings option. According to a recent Sallie Mae study titled “How America Pays for College,” only about one-third of parents and families saving for college use 529 Plans.
Named for the section of the Internal Revenue Code that created them, 529 Plans, also called “qualified tuition plans,” are sponsored by states or educational institutions. There are two types of 529 Plans: prepaid tuition and college savings plans.
Prepaid Tuition v. College Savings Plans
Prepaid plans are generally sponsored by states and have residency requirements attached, so they’re good for students who plan to attend university in the state where they live. Families saving for college can purchase credits at participating schools to cover tuition in the future.
College savings plans allow the account holder (often parents or other family members) to set up investment options on behalf of a future college student. These could be mutual funds, age-based portfolios, or money market funds. Most universities accept withdrawals from these funds to cover tuition. The U.S. Securities and Exchange Commission has more details on each type of plan here.
While a 529 Plan has many benefits, it can also reduce a student’s eligibility for federal financial aid and restrict investment options in other areas.
Commonly Asked Questions About 529 Plans
How will investing in a 529 Plan affect my taxes?
The IRS actually cites tax benefits as one of the main advantages of 529 Plans. Earnings accrued through 529 Plans are not subject to federal tax, and are often exempt from state taxes—as long as you fulfill requirements like using withdrawals exclusively for tuition or other college-related expenses, like books or housing. Many states even offer tax benefits including matching grants. However, if you withdrawal from your plan and don’t use the funds for college, you will be taxed, and could also pay a 10% penalty. Contributions to the plan are not tax deductible.
Are there restrictions on 529 Plans?
Yes, there are some restrictions. The Securities Exchange Commission explains that you can only withdraw money without penalty if you’re using it for eligible expenses. Investment options are also limited while saving in a 529 Plan: account holders can change investment options up to twice a year. However, Joseph Hurley, founder of Savingforcollege.com, recently told the Wall Street Journal that shouldn’t dissuade investors, because regular changes are not necessary to successful returns with a 529 Plan.
Will investing in a 529 Plan affect my financial aid availability?
529 Plans are considered parental assets when schools are evaluating financial aid. Parental assets altogether are factored into the financial aid formula at a maximum rate of 5.6%, so 529 Plan investments won’t make or break the total financial aid award. Keith Bernhardt, vice president of college planning at Fidelity Investments, says that’s another argument in favor of 529 Plan investments for parents worried about covering college costs. “This lower rate means that every dollar saved in a 529 college savings plan can go a long way toward helping to pay for college without significantly affecting financial aid for the student,” Bernhardt said
If you’re thinking about starting a 529 Plan for your children or grandchildren, consult the firsthand documentation provided on the IRS or SEC website. SavingforCollege.com has a tool that will let you compare plans state by state. If you’re having difficulty deciding whether this saving strategy is right for you, the estate planning team at Anselmo, Lindberg and Associates has years of experience helping parents just like you ensure their kids have the best start in life. Contact us today to learn more about your options. For more estate planning tips for parents, check out our archives here.