Paying for College With The 529 Plan

 

529 Plan
Time to save!

Who has heard of the 529 plan?

Whether you’re the parent of a newborn, or your little one is in elementary or perhaps even making their way through middle school, there is no time like the present to start saving for college.

Many may think that just a regular savings account would be sufficient to start saving for tuition and textbooks.  However, there is another investment vehicle that you can use to get rolling.  Similarly to how one can stash away funds for retirement in an IRA, those wishing to save and invest funds for college can choose the 529 plan.  Read on for more.

What is a 529 plan?

According to the SEC, “a 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.”

There are two types of a 529 plan, prepaid tuition and college savings plans.

Prepaid Tuition

The SEC states “prepaid tuition plans let a college saver or account holder purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and mandatory fees at current prices for the beneficiary. Prepaid tuition plans usually cannot be used to pay for future room and board.”

Generally most prepaid tuition plans receive sponsorships from state governments and can also contain residency requirements for the one who is saving for college or the beneficiary.  It is important to note that these types of plans are not guaranteed by the federal government.  Some of these state governments will guarantee the money that you put into the plan, however others will not.  That being said, the importance of checking your individual state’s guidelines cannot be stressed enough.  For example, if your investments are not guaranteed by your state, and the plan’s sponsor should go broke or have some other sort of shortfall, then you could lose some or all of your money.

College Savings Plans

With this particular plan, “a college saver can open an investment account to save for the beneficiary’s future qualified higher education expenses – tuition, mandatory fees and room and board. Withdrawals from college savings plan accounts can generally be used at any college or university, including sometimes at non-U.S. colleges and universities. A college saver may typically choose among a range of investment portfolio options, which often include various mutual fund and exchange-traded fund (ETF) portfolios and a principal-protected bank product. These portfolios also may include static fund portfolios and age-based portfolios (sometimes called target-date portfolios). Age-based portfolios automatically shift toward more conservative investments as the beneficiary gets closer to college age.”

Almost on the opposite end of the spectrum, all college savings plans ARE sponsored by state governments and only a few have residency requirements for the saver or the respective beneficiary.  It is also worth noting that state governments do not guarantee investments in college savings plans.

Also worth noting is that college savings plan investments within mutual funds and ETFs do not get federally guaranteed, however, should you make some of your investments in some principal-protected bank products, those may be insured by the FDIC. Don’t forget too that similarly to most investments, investments within college savings plans have the potential to not make any money and could lose some or all of the money invested.

Additional Perks

As an added bonus, investors saving for college within a 529 plan may also get additional tax benefits.  Of course, make sure you understand the tax implications of investing in a 529 plan and consider whether to consult a tax adviser.

One perk is that many states will offer tax benefits for contributions to a 529 plan. Benefits can include deducting contributions from state income tax or matching grants. However, college savers may only be eligible for these benefits if investments are made in a 529 plan sponsored by that specific state of residence.

Also when it comes to 529 account withdrawals for qualified higher education expenses, earnings in the 529 account are not subject to federal income tax and, in most cases, state income tax. If 529 account withdrawals are not used for qualified higher education expenses though, they will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings.

Final Thoughts

While there are certainly other options for saving for college out there, if managed properly, the 529 plan can be a great investment vehicle while saving for your child’s college expenses.  If you would like to learn even more, the SEC offers up additional information and circulars for your reference to see if this might be a good fit for you and your family.

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