What are 529 Plans? How do you open and set up a 529 Plan? In simple terms, this post introduces and provides suggestions on 3 Ways you can start saving for college today.
While the specific rules vary from state to state, this post will give you some essential context for consideration. These plans are a fantastic tool to help save for college, help support your children and provide for their future as well.
An Overview and Introduction to 529 Plans
The costs for college have been on the rise, and they appear to continue on that trajectory. While a traditional 4-year degree may not be for everyone, a straightforward approach for those who plan on attending is likely to be big bucks. Factoring in rising inflation, costs and taxes will also weigh down the household budget making it more difficult for those who would like to save for their children.
What’s the solution? Firstly, and for those who have been with us now for a while, a proper budget is essential. Use it to navigate the financial waters of life. An iceberg in those waters could be paying for higher education.
However, the key point of this post is a handy financial tool called a 529 Plan. As part of a multi-layer plan for college, 529s could also offer various tax-based benefits depending on your State’s plan. So, let’s roll up our sleeves and continue working on strengthening our Mêtis in Money Matters!
What are 529 Plans anyway? Definitions and Framework.
The 529 Plan is a tax-efficient way to start saving for the beneficiary’s qualified education expenses. Is this limited to college only? Not necessarily! More on that, below.
529 Plans – Definitions and Framework
From my personal experience, the context of a 529 plan has always been to pay for college. It was sort of a black box that I wasn’t familiar with.
Fast-forward several years, and I wish I would have started one of these sooner! They are powerful financial tools and offer good benefits now, for those contributing, and for the plan beneficiary.
Key Roles Defined
Let’s take a quick moment and define some common terms to help us in our research along the way. (We’ll use New York as an example).
- Plan Sponsors: are the respective States (e.g. NY 529 Plan).
- Plan Administrators/ Plan Managers: are those managing the plan (e.g. Ascensus) and can vary depending on which 529 plan you use.
- Plan Investment Manager – This is where you are investing the funds contributed into the 529 Plan; common companies include Vanguard, Fidelity, and Templeton.
- Account Owner – This is the person who opens, owns, and controls the 529. In our case, my wife and I own the accounts we have set up for our children (the beneficiaries).
- Account Beneficiaries – This is the recipient of the 529 plan. In our case, our children are the beneficiaries of their respective plans.
- Account Contributors – The person(s) putting money into the account. This can be the parents (as in our case), friends, or family members (like on birthday!).
Types of 529 Plans
According to the SEC, these qualified tuition plans come in two flavors (more below) which vary depending on your needs and availability. Take a look at these summaries, below, for some context. Get a feel for the best fit, and then sit down with a trusted financial advisor or tax professional to help with the finer details associated with your financial situation.
Prepaid Tuition Plans
Typically used for public and in-state colleges, this plan allows for purchasing units/ credits in advance for future use, effectively “locking-in” a rate. There are details to consider, such as residency requirements and there are also requirements on qualified expenses, etc. These are not guaranteed by the government, and there are additional rules and variations depending on your state. Unless there is a narrow, focused need, I generally do not recommend this option.
Education Savings Plans
For most of us, this is a fantastic route! This post is written in the context of the Education Savings Plan. Assuming the rules are followed and the funds are applied to qualified expenses for higher education, this can include tuition, some fees, and room & board. There is a much broader list of eligible institutions, including some non-US-based, public or private, and so on.
Additionally, these allow for contributions to be directed toward myriad investments for purposes of saving and growing your hard-earned dollars until the right time. We’ll cover more on this in the section, below. But for now, keep in mind that this is a great way to save for a broad range of education needs from elementary school through college!
How do 529 Plans Work?
My friend, I am excited about these plans, and I hope you are too! In this section, we’ll zoom in and talk more about the details behind how the 529 Education Savings Plan can work hard for you and your family.
Fees, Penalties & Contribution Limits
You’ll want to check the current year’s limits and the state-specific plan. In general, the plan cannot exceed the cost of qualified expenses. At the time of this post, this amount turns out to be over $300,000 of lifetime contributions in my state.
Looking to compare, research, and identify your state’s contribution limits? Here’s a great resource you can use.
Fees and Penalties related to the Fund
Can result from using the expenses on non-qualified expenses (in the tune of being taxed and tagged with a fee of 10%), and a few other scenarios including if the 529 plan is transferred to someone else (could incur a federal tax).
In particular, look for the 529 Plan Offering Circular to better understand what fees you might be faced with in various scenarios. Keep in mind, these fees take away from the amount you’ll have available. Understanding them is time well spent.
Didn’t end up using it – can you switch the Beneficiary?
In a word, YES! This is a great benefit and can be transferred to a broad range of family members. Consult with a trusted financial advisor as there could be additional taxes associated with the transfer.
This offers more options and provides some reassurances the funds can be used for the intended purpose.
Qualified Withdrawals: What Education Expenses are covered with 529 Plans?
This is important to understand upfront when preparing and planning for the qualified educational expense(s). Focusing on college, and assuming the student is enrolled at least 1/2 time, here are some points to consider:
Concerned the qualified expenses might be out of reach, or too narrow to be helpful? You might be happy to hear that there is a broad range of qualified expenses. In general, this includes tuition, room and board, required textbooks, computers, and more!
There are rules to be aware of, and it would be good to coordinate with the school’s administration office to identify what those expenses are. It is also a good idea to acquaint yourself with the State-specific regulations associated with that particular 529 plan.
Additionally, if you want to use the 529 to pay for room and board, you’ll also need to coordinate that with the school to ensure you’re adequately saving and preparing for that cost.
Keep your receipts! Keep detailed records!
Federal and State Taxes, and Gift Tax
Your 529 earnings grow tax-free and qualified withdrawals are free from federal income tax (provided the withdrawals aren’t greater than the qualified higher expenses). That’s great news!
Some states offer state income tax deductions for contributions as well. You’ll want to look for your state-specific guidance to better understand what options you have available.
Another helpful feature allows for others to contribute to the plan as “gifts” (e.g. family gifting 529 money on a birthday) of up to $75,000 as a lump sum. The detail to be careful of is that this constitutes essentially 5-years worth of ($15,000 each year) gifts at one time.
For more information, you can also check with the IRS and review Publication 970 (make sure to check for the most-current version each year).
What Schools and Institutions qualify?
More than you might think! Quite a few options including K-12, elementary, middle, high schools; and of course, university or college options (including myriad public, private, and religious schools) could be eligible.
Check with current-year rules, but remember each beneficiary, $10,000 can be spent on elementary, middle and high school tuition costs. Powerful!
How to Setup and Use your 529 Plan
As with all financial instruments, it is important to consult with your trusted financial advisor to ensure this is a good fit for you and your family. A few essentials to keep in mind are outlined below:
How to Open a 529 Plan
After selecting your state and 529 plan, you’ll want to review where to invest the contributions. To understand what fees you’ll be faced with for the respective investments, be sure to read the associated prospectus.
Who can Open a 529 plan?
The account holder (in our case, us, the parents) opens the account for the beneficiary (our children). However, you do not necessarily have to be related to the beneficiary to open one. Additionally, you can also open one for yourself!
To open an account you must be 18, have a tax id (or social security number), and have a permanent legal US mailing address.
529 Vanguard 529 Plan and Investment Options
Most plans offer some variation of the following allocations. If you’re not sure what you want, consider your “sleep at night” factor. What degree of downside are you ok with in exchange for higher potential returns? Also, consider how much time you’ll have until the funds are needed for the beneficiary. As a broad and general statement, if the time horizon is longer-dated, then you can accept more risk. Shorter-term will generally be better served by more conservative investments. Immediate needs might be better served by a Money Market account. Make sure to consult with your trusted financial advisor!
- Custom/ Manual Selection: You drive! Broadest range of options, picking from the list provided by the fund.
- Target Age Funds: This allows for a quick selection based on the age of the beneficiary
- Objective Specific: Aligned with specific risk preferences or tolerances
What impact will this have on Financial Aid?
As a rule, yes, it can. However, it may not be as bad as you think! Rules change depending on who owns the account, and FAFSA applicants should be aware of how that impacts what they are eligible for. Additionally, keep in mind that the institutions of learning may also adjust financial aid based on the 529 as well.
3 Ways to Use 529 Plans to Save for College
(1) Shop it around!
Some states offer tax parity, so if you’re in those states, then absolutely check out the competition! Each state will have a dedicated site with specific terms. Also, there are online comparison tools available as well which provide summary-level information to get started.
(2) Plan in advance
When touring schools or researching online, make a point to understand what they list as qualified expenses for things like textbooks, computers, tuition, and room and board costs (especially if your student is planning on living off-campus).
Doing a little bit of homework in advance can help save money and ensure your 529 funds are being used efficiently.
(3) Budget, and Track Expenses
College costs continue to rise! Budget now, prepare for the future and automate the contributions if you can. Many states offer low contributions, and this makes it easier to get started. Something is better than nothing!
When the time comes, make sure to save your receipts, and take care you keep track of what you’re spending the 529 on. Work with your trusted tax and financial advisors to ensure you are optimizing the available benefits.
Here are a few more posts that might interest you:
- Sinking Funds for Saving Money & Accomplishing Financial Goals
- Lessons Learned from “I Will Teach You to be Rich” – Book Review
- Preparing for a Happy Retirement without Sacrificing it All today
- Extreme Ownership: How U.S. Navy SEALs Lead and Win | Book Review
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