It can be hard to save for your child’s college education in addition to your own retirement funds. But if you can, one of the easiest and most cost-effective ways to save is a 529 plan. Here are the points you need to know.
1. Anyone can set-up a 529 plan
Anyone can set-up and contribute to a 529 plan including parents, grandparents, other relatives, and friends. And you can contribute to a 529 regardless of your income level — there is no income phase out like there are for ROTH IRA contributions.
2. Earnings grow tax-deferred.
You have to pay ordinary income taxes on the money you contribute to a 529 plan, but then the earnings grow tax-deferred. This can make a big difference to the end amount, especially if you start early. It also helps with paperwork at tax time. You do not have to report earnings until you begin withdrawing funds for college expenses.
3. Withdrawals from 529 plans are tax-free when used on qualified college expenses.
You will not pay federal or state taxes when you take out the money as long as it’s used for qualified college expenses. These expenses include tuition, fees, room and board, books and supplies.
4. Many states offer tax advantages.
Many states offer tax deductions for contributions made to their state sponsored 529 plan, so make sure to research the tax rules for your state before choosing a plan. (For California residents: California does not offer a state deduction so go ahead and shop around — there’s no tax benefit to choosing California’s plan.)
5. Owner retains control of the account.
The owner retains control of when distributions will occur. The beneficiary does not gain control at a certain age. This differs from custodial account where the beneficiary gains control at age 18 or 21.
6. Low financial aid impact.
A 529 plan owned by the parent or the child is considered an asset of the parent in determining your child’s Expected Family Contribution (EFC) for financial aid. When calculating EFC, parents are expected to contribute 5.64% of 529 plan assets each year for college costs.
7. 529 plans offer flexibility.
529 plans offer flexibility if your child decides not to attend college. The owner can change the beneficiary to a relative of the child to use for college or graduate school expenses.
If it ends up you need the money for non-qualified expenses, you can still take the money out of a 529 plan. You’ll pay ordinary income taxes and a 10% fee on the earnings (but not the contribution amount).
8. High Contribution Amounts
A parent is allowed to contribute up to $14,000 per year, per student. That’s a combined $28,000 per year for both parents.
9. Easy to set-up and manage.
Set-up usually includes minimal paper work, a low balance to start, and automatic invest plans. For easy management, select the age-based option that automatically invests more in bonds as your child gets closer to college age.
10. Selecting a fund.
Morningstar puts out a rating report on 529 plans that’s helpful. If you’re a fan of index funds, check out Utah Educational Savings Plan or the Vanguard 529 College Savings Plan administered by Nevada. Plus, you can change plans once a year if you’re not happy with your choice.
It can be overwhelming with all the choices out there but don’t let that stop you from starting. It’s hard to go wrong with a low cost 529 plan.