As the cost of education in the United States continues to rise, it’s becoming more and more important for parents to plan ahead. Fortunately, a 529 savings plan offers a solution to help alleviate the financial burden of education. The 529 savings plan is designed to help families save for education expenses by providing tax benefits and flexible investment options.
What is a 529 plan?
A 529 plan, named after section 529 of the federal tax code, is a way to save for college in a tax-advantaged way. Plans are offered by states, and you can choose to participate in any state’s plan. It’s important to compare benefits to pick which plan best suits your needs.
There are two types of 529 plans—savings plans and prepaid tuition plans.
- With a 529 college savings plan, your investments grow in an individual investment account (tax-free).
- With a 529 prepaid plan, you lock in a tuition payment at the current rates. The amount then goes into a general fund (rather than an individual investment account).
Between these two plan types, 592 savings plans are more common, as they have notable benefits.
Tax-free Growth and Withdrawals
A 529 savings plan works similarly to a Roth 401(k) or Roth IRA. You select the investment option you want, deposit money, and your funds build over time in the account. Your investment grows on a tax-free basis. Money can also be withdrawn tax-free if used to pay for qualified higher education expenses.
Anyone Can Contribute
According to Education Data Initiative, Americans on average aim to save $55,342 for their child’s college expenses. With a 529 savings plan, a parent isn’t the only one who can contribute. Any friend or family member can make gift contributions to a beneficiary’s account. For birthdays and holidays, loved ones can make a lasting impact on the beneficiary’s future, cutting down on future student loans. The funds can be used to cover the beneficiary’s education costs, which are more than just tuition; these also cover textbooks, room and board, and other academic expenses.
529 Savings Plans Can Be Used for More Than College Costs
Besides college expenses, the funds can also cover expenses for K-12 education. You can apply $10,000 per year toward private elementary or secondary school tuition expenses.
Flexibility to Change the Beneficiary
If your child chooses not to attend college or receives a scholarship, all is not lost. You can change the beneficiary to any other qualifying family member. This option helps families avoid paying taxes and fees on unused funds.
A Little Goes a Long Way
Small amounts truly add up over time and make a significant difference. Outstanding U.S. student loan debt reached $1.7 trillion at the end of 2020, according to the Federal Reserve. A 529 savings plan allows you to make a considerable dent in college costs, even if you start while the child is in high school. It is never too late—every penny counts.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that an education-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10 percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.