How To Choose A 529 Plan
Since you can invest in any states 529 plan, not just your own states 529 plan, you have many choices available.
- Consider your own states plan, especially if you live in one of the 35 states that provide state income tax deductions or tax credits for contributions to the states 529 plan.
- Look at 529 plans that offer the lowest fees. Minimizing costs is the key to maximizing the net return on investment.
- Compare 529 plans based on net performance, after subtracting the fees.
You can enroll in a 529 plan directly, or through a financial advisor. Although advisor-sold plans come with higher fees, a financial professional with college savings expertise will be able to help with choosing a plan and selecting investment options.
Is There An Age Limit On A 529 Plan
529 college plans are relatively flexible, which is one of their appeals, and there is no age limit to get started. You can use it to pay tuition at a four-year undergraduate program. If there is money left over in the plan, you can use it later to help cover continuing education or even to help pay back graduate student loans.
If your child doesnt go to college or graduate school, you could always withdraw the money or use the funds to pay for other expenses but it will cost you. If you use the money in your 529 plan to pay for unqualified education expenses, you will have to pay federal income taxes and a 10% penalty on the earnings.
You Have Options When Selecting A Plan
There are two basic types of 529 plans:
- Prepaid tuition plans: You lock in current tuition rates at in-state public institutions. If your child decides to go to a private or out-of-state institution, you might receive only a small return on your original investment.
- Savings plan: You contribute regularly and rely on the accounts earnings to grow. You take on more investment risk while giving your child the opportunity to use the funds at public and private schools nationwide.
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What If My Child Decides Not To Attend College
You donât lose your 529 plan money if your child doesnât go to college, but there are some consequences. First of all, the funds donât need to go towards a four-year degree. 529 plan money can go toward trade and vocational schools, as well as tuition for K-12.
If those options donât apply to your child, there are a few other ways to use the funds, although the financial implications vary.
- Change beneficiaries: You can name another beneficiary, usually anyone related to the current beneficiary. You could also name yourself as a beneficiary if youâve considered going back to school.
- Leave the funds: Another option is to leave the 529 alone in case your child changes his mind or someone else in the family could use the money for school later on.
- Take a penalty: You can still withdraw unused money from a 529 college saving plan, you just have to pay for it. Expect to pay federal and state income taxes on your withdrawals, plus a 10% penalty on earnings.
What Is A 529 Plan How It Works And How To Use It
Editorial Note: The content of this article is based on the authors opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.
A 529 plan is a tax-advantaged savings account designed to help people pay for education-related expenses. These plans are administered at the state level, and each state offers different types of accounts with different specifications. Some states allow you to open 529 accounts offered by other states.
What 529 plans have in common is that money in these accounts grows tax-free and withdrawals for qualified educational expenses are also tax-free. These plans can often be used for a wide variety of expenses, though sometimes theyre restricted to paying for tuition. Those significant tax advantages are why 529 plans are a smart way to save for college.
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What Are The Benefits Of This Account
There are financial benefits and Wisconsin offers tax breaks for residents who contribute to 529 college savings plans.
Research also has found having an account, no matter how much is invested in it, makes it more likely a child will attend college.
One study found that among children who expect to go to college, those with a savings account are six times more likely to attend than those without one.
Having a savings account was a better predictor of whether a child with those expectations would attend college than race or parents net worth, the study showed.
What Happens If My Child Doesnt Use The 529 Plan
If your child opts not to go to college or other vocational school, the beneficiary can be changed to another family member who might be able to use the money. In general, the plan can continue holding the funds indefinitely as long as it has a living beneficiary listed.
However, eventually if the money cant be used, it must be withdrawn. If the money isnt used for qualified educational expenses, youll have to pay taxes on the earnings, as well as a 10 percent penalty.
However, there are ways to get the money back without paying the 10 percent penalty :
- Scholarship. If the beneficiary received a tax free scholarship, you can withdraw money to the amount of the scholarship.
- US military academy attendance. This is treated as a scholarship.
- Beneficiary death. If the designated beneficiary dies, the amount can be withdrawn.
- Beneficiary becomes disabled. A physician must certify that the beneficiary cant complete gainful employment.
- Employer education assistance. If an employer offers assistance, that amount can be withdrawn without paying the penalty.
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Strategies Before You Make A Non
Since most non-qualified withdrawals are penalized, you should only do so after carefully examining all your options. In many cases, a better strategy is available that will allow you to keep more of the funds youve worked so hard to accumulate. Before you commit to a non-qualified withdrawal, consider the following.
- Do you have other qualified expenses coming up? Paying for rent, books, and supplies would be a better option for these funds and wont subject you to a penalty.
- Will your child go on to grad school? If your child is heading to law, medical, or grad school, your 529 savings can usually be used for these expenses, too.
- Can you choose another beneficiary? Switching your 529 plan savings to a younger child can help you save and jump-start that family members college savings.
- Can you just withdraw from the principal? You can withdraw the amount you invested without penalty, but leave the growth in place to avoid being penalized.
Choosing Between Different 529 College Plans
Another type of 529 plan is the prepaid tuition plan. The difference between this and the 529 college savings plan is that it allows account holders to purchase credits or “units” at participating educational institutions that can be applied in the future toward tuition and fees for their child. While you can prepay for tuition, these plans don’t typically cover future room-and-board costs, which is an expense covered by a 529 plan.
The main benefit of a prepaid tuition plan is that you have the potential to save on tuition, since you’re paying today’s price for future tuition. However, if your child doesn’t attend a specific school , you may lose part or all of your money. Even if you’re able to transfer some or all of your funds to another participating institution, the value may go down.
“Prepaid plans are less popular today because to take advantage of its full financial benefit, the beneficiary must choose from a select few eligible institutions,” Wang says. “For most people, the limitations outweigh the benefits.”
Hemphill agrees, and adds it’s important to look at all the pros and cons before deciding on a prepaid plan.
“Prepaid plans lock in today’s college costs, but they don’t cover all costs,” she says. “Choosing the best plan for your family involves comparing the two options side by side and weighing what’s best.”
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Saving For College While Taking Advantage Of Compound Interest
Being smart about college savings means that you are making your childs education a priority. Not all 529 plans will fit your familys needs, and that is why you should consider turning to your financial advisor for guidance. They can help you assess the goals you have for your childs future education and help select a plan that aligns with these goals.
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How To Use A 529 Plan If Your Child Doesnt Go To College
It’s official: You are a super-parent. You looked ahead and, with love in your heart and financial sense in your head, you set up a 529 college savings plan for your child’s future education. You contributed to their college fund from early on, confident in your investmentuntil, one day, your child decides not to go for that diploma.
A 529 plan is great for college savings, but you’re essentially rolling the dice on whether an infant will want to pursue a college degree in 18 years. If your child doesn’t go to college, withdrawals from their 529 plan could be penalized and taxed, taking a chunk out of years of investments. However, you can still transfer or otherwise utilize your hard-earned savings without trimming off too much in taxes. Read on to learn how.
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The Abcs Of 529 Plans
If 2022 is the year that you start saving for your childrens higher education, then explore 529 college savings plans. Set up by the federal government in 1996, 529s plans are the tax-advantaged way to save for whatever education comes after high school for your child. There are many reasons to save in a tax-free 529 plan, especially when compared to the typical, taxable bank savings account.
Possible 529 Withdrawal Penalties
The most important thing to know about penalties and your 529 plan is that your principal can always be withdrawn without penalty. The money that grows over time is subject to penalties, though. Unlike normal investment accounts, the growth of your college accounts is treated and taxed as income and not capital gains.
If you remove funds for non-qualified expenses, then youll pay a 10% penalty on your gains. Youll also be subject to income taxes on the gains and may even have to pay back any state income tax deductions you previously claimed.
Since penalties do exist for non-qualified withdrawals, fully understanding the differences between qualified and non-qualified expenses and taking steps to minimize your penalties before you withdraw will allow you to keep as much of your hard-saved investment as possible.
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What Are Qualified Education Expenses
Remember, only qualified withdrawals are tax-free. That means you should only use your 529 plan to pay for qualified educational expenses. 529 plan withdrawals must happen in the same tax year as the expenses
Qualified expenses for college include tuition and fees, books and materials, room and board , computers and related equipment, internet access, and special needs equipment for students attending a college, university, or other eligible post-secondary educational institutions.
However, there are some costs that you may believe are necessary, but the IRS does not consider a qualified expense. For example, a students health insurance and transportation costs are not qualified expenses, unless the college charges them as part of a comprehensive tuition fee or the fee is identified as a fee that is required for enrollment or attendance at the college.
In recent years, the IRS has expanded the definition of qualified education expenses to include K-12 tuition expenses and student loan repayments. There is a $10,000 annual limit on qualified K-12 withdrawals and a $10,000 lifetime limit on student loan repaymentsThe funds in a 529 plan are yours, and you can always withdraw them for any purpose. However, the earnings portion of a non-qualified distribution will be subject to ordinary income taxes and a 10% tax penalty, though there are exceptions.
Custodial Accounts And Coverdell Esas
529 plans aren’t the only options for college savings. Custodial accounts and education IRAs are other ways you can set aside money for college expenses.
Money that goes into a custodial account is an irrevocable gift belonging to the child. The money out into the account lowers the family’s total taxable income as long as the child’s total income remains fairly low and that income comes solely from interest. However, custodial accounts that earn significant amounts of money for the child will be subject to taxation, which may eliminate their advantages. Other drawbacks include: the money has to be used for the child’s benefit, not for your own or your family’s the child can spend the money on anything once he or she reaches either 18 or 21 depending on your state’s age requirement money in the child’s name counts against the child’s eligibility for financial aid. Money in a custodial account can be converted to a 529 plan, but the child still technically controls it .
Congress improved Coverdell Education Savings Accounts significantly when Congress increased the annual contribution limit from $500 to $2,000 in 2002. Like 529 plans, ESA earnings are tax-free when used for education expenses, and they’re considered the parents’ asset so they don’t adversely affect financial aid eligibility. They do have some advantages over 529 plans, including more control over your investments and the ability to use the money for private elementary or secondary school expenses.
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Why Use This Plan Rather Than A Regular Savings Account
These 529 savings accounts help make sure the value of your money grows with the market. If you put a dollar in a savings account, in 20 years that dollar will not go as far because of inflation, since the costs of goods and services rise over the years.
Savings accounts have very low interest rates, ones that typically run far below investment returns. The 529 accounts give more potential for growth. The market does fluctuate, but the idea is to start an account early again similar to a 401 so the account can absorb those ups and downs and still come out with earnings.
What Happens To Money Not Used In A 529 Plan
If you have leftover money in your 529 plan and you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:
- Since January 1, 2018, parents also have the option to take up to $10,000 in tax-free 529 withdrawals for K-12 tuition
- Since January 1, 2019, qualified distributions from a 529 plan can repay up to $10,000 in student loans per borrower for both the beneficiary and the beneficiarys siblings
Remember, you can withdraw leftover funds in a 529 plan for any reason. However, the earnings portion of a non-qualified withdrawal will be subject to taxes and a penalty, unless you qualify for one of the exceptions listed above. If you are contemplating a non-qualified distribution, be aware of the rules and possible tactics for reducing taxes owed.
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What Is A Prepaid Tuition Plan
Technically, prepaid tuition plans are also 529 plans, but everybody calls them prepaid tuition plans. Hardly anybody calls them prepaid 529 plans any more. A prepaid tuition plan locks in tuition at current rates by letting you buy tuition units or years of tuition. A years tuition will always be worth a years tuition.
But, you will usually have to pay a premium on current tuition rates, to make up the shortfall between investment returns and increases in college costs. Many prepaid tuition plans are suffering from actuarial shortfalls and do not have enough money to cover all future tuition obligations. Some prepaid tuition plans offer guarantees, but their guarantees may not be backed by the full faith and credit of the state. Even if the prepaid tuition plan is guaranteed by the state, it isnt clear what the guarantee really means. Many prepaid tuition plans have closed to new investment and will not cover full tuition costs. The money might not be there when your child is ready to use it.
What Can 529 Funds Be Used For
Qualified 529 expenses include costs associated with post-secondary education. While some states and specific plans have restrictions on what counts as a qualified expense, common types include:
- Enrollment fees
- Educational supplies
- Apprenticeship program costs
Be sure to check whether a particular expense is qualified as part of your 529 savings plan before withdrawing funds from the account. Withdrawals for non-qualified expenses can incur expensive penalties.
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An Introduction To 529 Plans
May 29, 2018
Legislative Changes
Setting Every Community Up for Retirement Enhancement Act made some important changes to 529 plans.
- It allows 529 plan distributions of up to $10,000 to repay qualified student loans of the beneficiary. An additional $10,000 can be used for the qualified student loans of each of the beneficiarys siblings. The $10,000 cap is a lifetime not annual limit.
- It allows 529 plan distributions to pay for registered apprenticeship programs.
The SECs Office of Investor Education and Advocacy is issuing this Investor Bulletin to provide investors with background information on 529 plans. Please also see our companion Bulletin for a few questions to consider before opening a 529 plan account.
What is a 529 plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education 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 529 plans: prepaid tuition plans and education savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a prepaid tuition plan.
What are the differences between prepaid tuition plans and education savings plans?
What fees and expenses will I pay if I invest in a 529 plan?
What restrictions apply to an investment in a 529 plan?