529 college saving plans are a popular and effective way to save for a child’s college education. Here’s what you need to know.
In This Article
What Is a 529 College Savings Plan?
A 529 plan is an investment account used for education savings. Think of it as the educational equivalent of a healthcare savings account or a 401K.
The U.S. government introduced 529 plans in 1996. Generally affiliated with a state or educational institution, these plans provide a way for families to save for a child’s college or other educational expenses tax-free.
A 529 plan allows a parent or other individual to establish a tax-free investment account in the name of a designated beneficiary. Funds contributed to the account can be used for educational expenses (within program guidelines) without incurring federal tax.
Additionally, some taxpayers may also be eligible for a state income tax deduction or tax credit for 529 plan contributions, depending on their state of residence. To find out if you qualify for a state benefit, consult your tax advisor.
What Can You Pay for with a 529 Plan?
Many families aren’t aware of how beneficial a 529 plan can be for their children. In fact, fewer than 18% of all children have a 529 college savings plan opened for their future educational expenses.
With some investment accounts, you pay taxes on your earnings when you go to withdraw the money. A 529 is different. With a 529 account, your earnings are not subject to federal income tax when used for qualified education expenses, including:
- College tuition and required fees at an eligible institution, for both physical and online classes (The classes must be provided by a college or university that is eligible for Title IV federal student aid. This includes community college courses and undergraduate and graduate degree programs.)
- Books and supplies (including lab materials, safety equipment, and other supplies required to complete college coursework)
- Computers, internet access, software, and “peripheral equipment” like speakers or a computer mouse
- Special needs equipment required for enrollment or attendance at a qualified college or university
- On- and off-campus room and board, so long as the student is enrolled at least half-time
- Rent during the summer months, providing the student is enrolled at least half-time
- Room and board while studying abroad (excluding travel costs)
There are, however, college expenses that can’t be lawfully paid for by 529 plan funds. These include:
- College application fees
- Health insurance costs (even if offered by the college)
- Transportation on campus or to and from college
- Extracurricular college activities
Additional 529 Savings Plan Uses
The definition of qualified higher education expenses has also been expanded beyond that of a college education on several occasions, including in:
- 2018 to include up to $10,000 annually in K-12 public, private, and parochial school tuition, via the Tax Cuts and Jobs Act
- 2019 to include student loan payments up to a lifetime limit of $10,000 and the cost of apprenticeship programs, via the SECURE Act
Despite the expansion of acceptable 529 fund uses, professional and workforce certifications are currently excluded from the list of qualifying expenses. However, this may change soon.
The Freedom to Invest in Tomorrow’s Workforce Act, a bipartisan bill introduced to Congress in March of 2021, aims to allow individuals to use their 529 college savings plans to cover the cost of certain workforce training and credentialing programs.
What Is the Best 529 College Savings Plan?
One of the main benefits to a 529 plan, besides being tax-free for qualifying expenses, is that the funds are invested. That means your funds will continue to grow between the time of contribution and the time they are disbursed for educational expenses.
Many 529 plans offer the plan owner a choice of options to invest the money. The best 529 college savings plans are those with a strong investment rating and historically solid performance of returns.
When considering 529 plans, you may want to avoid those with:
- State residency requirements (Some plans stipulate that the student must attend college in a certain state or states, which can limit your child’s college options.)
- A high initial investment threshold
- Application fees
- Excessive investment fees (Some investment plans charge investment or brokerage fees, such as annual fees for maintenance, fees to change investments, etc. Avoid plans with fees exceeding .25% of assets.)
For more help finding the best 529 college savings plan for your family, consult the rankings of the best 529 plans for 2021.
How Much Should You Save for College?
As with saving for retirement, the earlier you start, the better off you’ll be. However, it’s never too late to start. A college cost calculator can help you determine how much you should contribute to a 529 plan.
Once you have a ballpark estimate of future educational expenses, you can create a college savings plan. Financial advisors typically recommend that you save one-third of the expected total college cost for each child and plan to make up the rest through financial aid, scholarships, and additional money from a parent and/or student’s income during their college years.
How to Start a 529 College Plan
Once you’ve settled on a plan that meets your child’s needs, opening a 529 account is fairly straightforward. After providing the required information (such as Social Security numbers, address, bank account info, etc.), however, you will need to consider the duration of the investment period.
For a newborn child, you’ll have upward of 18 years to invest. Though for an older child, you’ll obviously have less time to save (and earn interest), which means you may want to allocate more money at a time. Many plans will provide options geared toward your expected timeframe for needing the funds. Then from there, all you need to do is start contributing.
What Happens If Your Child Doesn’t Use the Money in their 529 Plan?
What if the person for whom you started a 529 plan, doesn’t end up needing it? Know someone else who might? Account owners may put the account in someone else’s name. This offers the flexibility to transfer the plan to another student in the event that the original beneficiary:
- Gets a full college scholarship
- Decides against going to college
- Finds that the 529 plan balance will impact receiving certain financial aid
In the event that there is no one in your life who you wish to transfer the plan’s funds to, you can always withdraw your funds from the plan. Just keep in mind that you’ll have to pay the taxes you would have normally paid on the fund’s income, plus a 10% penalty.
The cost of higher education continues to rise each year, making 529 plans a valuable tool for savvy parents. Opening a 529 college savings plan is one way to help the next generation maximize their potential and set them up for career success!