If you think there is no way you can afford to save for your children’s education, you’re not alone. As of 2017, only 20% of the parents in the U.S. were saving for college.
But consider this: Statistics show that students who have a college savings of only $1 to $499 are three times more likely to attend college and four times more likely to graduate from college than students with no savings at all!
By starting a savings account, your children know their education is a priority for you. ANY savings at all and your child is four times more likely to graduate college.
Statistics also show that 66% of millennial parents aren’t familiar with a 529 Plan for college savings, and only 4% of U.S. households are invested in a 529 Plan.
A 529 Plan is simply an educational savings plan that is exempt from federal tax. This plan also has tax benefits at the state level, if your state has an income tax.
These 529 Plans began over twenty years ago to help taxpayers prepare for education expenses. Let’s look at:
A 529 account is an investment fund. There are generally two different types of investment options:
With an age-based option, your investment starts out in higher-risk stocks, which also tend to yield much higher growth. As your child ages, the fund gradually shifts investments to more conservative mutual funds and bonds.
With a static option, your investment begins and remains in a lower-risk fund or group of funds. This plan is more secure but yields lower returns.
You often can choose the plan that feels right for your goals. Stocks can be riskier, but there is more money to be made. Bonds are generally safer but make less money. Some plans offer insurance-backed guarantees or principal-protected funds, meaning the money you invest can be recouped.
A 529 Plan will be handled by the program manager, which is usually a fund company or financial institution. Most managers invest in U.S. stocks and bonds and diversify through emerging markets, commodities, and international investments. The money is invested in your name, but in custodial accounts (each account is for a specific beneficiary).
Although handled by the program manager, you have the final say in how your money is invested. You can also work directly with an advisor who will explain all the options to you.
The two types of 529 Plans are College Savings and Prepaid Tuition. College savings are investment plans that invest your after-tax contributions in mutual funds. Prepaid Tuition plans are accounts that lock in the current cost of tuition.
Prepaid Tuition plans, however, are diminishing in accessibility. Many have stopped accepting new investors, others have even closed accounts completely. Prepaid Tuition accounts have other drawbacks as well. For instance, your investment may only apply to in-state schools. Also, room and board and many other costs are not included.
While Prepaid Tuition plans have time limits for withdrawals, College Savings plans do not have time limits.
Bear in mind that, like your cell phone bill or mortgage, your investment will be subject to fees. Fees generally include:
These fees are pretty standard and can range widely, depending on the amount you contribute, your state’s regulations, how diverse your investments are, and how actively managed your funds are.
Some states waive certain fees. Be sure to ask your plan managers about any waivers that may apply. Also, your state tax deduction, where applicable, may counter some of your fees.
First, contributions to your 529 Plan or Plans are not deductible from your federal income taxes.
Still, more than half the U.S. states offer state income tax incentives or tax credits for 529 contributions. To get these deductions, you may be required to invest in your legal home state’s 529 plan.
Second – and more encouraging – funds that grow from a 529 plan are free from federal tax, and will not be taxed even when the money is withdrawn for qualifying educational expenses (we will cover these specifics later.)
For tax purposes, the IRS doesn’t specify a yearly contribution limit for 529 plans, since they are considered gifts. And while most of us don’t have to worry about hitting a maximum amount, there are still some rules to keep in mind.
For 2019, to qualify for the yearly tax exemption, contributions may total up to $15,000 per plan, per individual contributing to the plan. So, while only one person can own the account, and each account can only have one beneficiary, multiple people can contribute the maximum to an account and still get the exemption.
As far as a minimum is concerned, each plan has a different initial start-up amount (often as little as $25), but after the 529 Plan is in place, any further contributions are optional. You can start it and forget it, set up monthly withdrawals from your bank account, or make occasional lump sum contributions after holidays or tax returns.
The point is, you decide when and how much.
You can withdraw the money in a 529 Plan for any reason. However, if it isn’t used for qualifying educational expenses, it is subject to taxes and penalties. The IRS does allow tax-free withdrawals of up to $10,000 per year for qualifying educational expenses. Either way, you will need to report withdrawals on your annual tax returns.
A 529 Plan can be used for accredited colleges and universities, and other eligible post-secondary educational institutions like trade schools and graduate schools. Qualifying educational expenses include:
Non-qualifying expenses include things like health insurance, transportation costs, and – surprisingly – student loan payments. Withdrawals for these purposes will result in a 10% penalty and will also be subject to income taxes.
What happens if the beneficiary of a 529 Plan chooses not to attend school, or doesn’t need the plan due to being awarded a full scholarship or being selected to attend a U.S. Military Academy?
If these situations occur, you have multiple options for your 529 Plan without incurring taxes or penalties:
As of 2018, all 50 U.S. states and the District of Columbia offer 529 College Savings Plan, and over half of those have tax incentives. Eleven states continue to offer 529 Prepaid Tuition Plans. U.S. News has a breakdown of each state’s regulations and policies that are worth checking out. Also, NerdWallet lists a state-by-state breakdown to include the names of each 529 Plan, what the tax benefits are, and what the minimum contribution requirement is.
The 529 Plan was created by Congress and named after section 529 of the Internal Revenue Code. Its legal name is the “Qualified Tuition Program,” and the IRS has a thorough Q&A page that covers any further questions and concerns you have.
Remember that saving always costs less than borrowing. A little now can go a long way later, both financially and motivationally. Just knowing you have invested in their future can make all the difference for your children. And with multiple 529 Plan options, you are sure to find one that meets your budget, your risk-comfort, and your financial goals.
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What State is your 529 in? Did you pick by highest returns, low fees or you just went with the state you’re living in? I’m in Texas which means no tax credits so I’m thinking about an out of state plan and wanted advise on choose a state other than Texas.