What is a 529 Plan? College Savings 101Submitted by Heath Wealth Management - Elijah Heath on January 15th, 2021
It may be tempting to delay saving for your child's future college expenses, especially when your budget is tight. Waiting to begin saving for college creates challenges because the amount of time to save keeps shrinking while tuition costs keep rising. Setting aside even a small amount as early as possible, and looking for ways to increase that amount slowly, provides the most incredible opportunity to save for college and stay on track with your budget. One option to consider is a 529 savings plan, offered by every state in the country.
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. The IRS established these tax-advantaged savings plans in 1996. The name of the plan comes from Section 529 of the Internal Revenue Code. An educational institution or the state usually operates these plans. All 50 states and Washington DC use at least one of the two types of 529 plans. These two types of plans are:
Pre-paid tuition plans - these plans allow you to pre-pay some or all of a college education. 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 approximately 250 private colleges and universities that 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 goes up and down based on how the investments are performing.
Education planning for your child allows you and them to take advantage of the best options in the future, using funds you've saved for that goal.
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 pre-paid 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 is 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 quarterly updates 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.
What Does a 529 Plan Pay For?
Earnings from a 529 plan don't get taxed, which gives these plans a significant advantage. And as long as funds go towards qualifying expenses, you won't get taxed on withdrawals either. Here are a few of the higher education costs that are eligible:
-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, and other essentials)
-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, one can withdraw up to $10,000 annually to cover 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 Save for College?
While saving any amount for college is beneficial, you may be wondering if what you are 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 for rent, utilities, groceries, and that you already have an emergency fund. After those necessities are taken care of, it's worth noting 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 5-8% a year, well above the 2-3% typical of annual inflation.1 While you cannot predict how the economy will perform in the future, you can estimate. With this information, you can calculate what college will cost when your child gets there and how much you should 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®.
1 Why Do Tuition Rates Rise Faster Than Inflation? (2020, December 02) https://www.edvisors.com/plan-for-college/saving-for-college/tuition-inflation/