529 College Savings - A Primer

College Savings, 529 Plan, Save for College Saving Ideas, Out of State Tutions

Sending a kid through college seems like a very daunting task. Kid you not, it is, if you have not planned it ahead of time. Education has become exponentially expensive, handily outpacing inflation. Even the in-state college fees have far outpaced inflation, and with inflation itself on the rise, it is an expense that can spiral outwards if not targeted early.

There are several ways you can be saving for college, but one of the most tax efficient tools provided by the congress is a 529 college savings account.

What is a 529 Plan ?

A 529 plan is a Tax efficient savings plan designed to help pay for education. Originally limited to postsecondary education costs, it was expanded to cover K-12 education in 2017 and apprenticeship programs in 2019. You can use the money in your 529 for a wide range of educational expenses including college expenses, K–12 tuition, certain apprenticeship costs, and even student loan repayments. There may be tax advantages to saving in a 529 plan. As long as the money stays in the account, no income taxes will be due on earnings. When you take money out to pay for qualified education expenses, those withdrawals may be federal income tax-free—and, in many cases, free of state tax too

529 plans are named after section 529 of the Internal Revenue Code. While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence. Contributions to 529 college savings plans are made with after-tax dollars. Once money is invested in the account, it grows tax-free, and withdrawals from the plans are not taxed when the money is used for qualified educational expenses.

Types of 529 Plans

Primarily there are two types of 529 plans, Prepaid plans and Savings plans. Let's look at details on both these types of accounts.

Pre-Paid Plans

Prepaid plans allow one to purchase tuition credits at today's rates to be used in the future. Therefore, performance is based upon tuition inflation. They may be administered by states or higher education institutions. Currently, 10 states provide a prepaid tuition plan that is accepting new applicants. Those states include Florida, Illinois, Maryland, Massachusetts, Michigan, Nevada, Pennsylvania, Texas, Virginia, and Washington. Prepaid tuition plans allow parents, grandparents and others to prepay tuition at today’s tuition rates at eligible public and private colleges or universities, helping them manage future tuition costs. You pay for amounts of tuition (years, credits or units) in one lump sum or through installment payments. There are a number of options. Some prepaid tuition plans offer contracts for a two-year community college or a four-year undergraduate program, or a combination of the two, and can cover one to five years of tuition. Some plans even allow the contract to be applied to graduate school tuition. With only a few exceptions, however, most prepaid tuition plans do not cover other expenses, such as room and board. So you may want to consider other college savings options to cover these costs.

Unlike the 529 Savings plans, most state prepaid plans require either you or your child be a resident of that state offering the plan. Many have a age or grade limits for beneficiaries. Prepaid tuition plans also have no investment options. You are paying tomorrow's tuition at today's prices. The price of the contract is determined by the type of contract and current grade of the beneficiary student and projected cost of tuition. When a child is ready to withdraw money from the account towards his or her tuition, the plan transfers the funds to cover the cost of tuition directly to the institution.

Savings Plans

In the Savings plans you can use the money in your 529 for a wide range of college expenses at accredited schools nationwide in addition to tuition expenses for K-12, certain apprenticeship costs, and student loan repayments. Contributions to a 529 savings plan go into an investment account managed by your plan’s fund manager, which is normally an investment firm or bank. Once you open an account, both you and others, such as grandparents, can put money into it. Funds from a 529 savings plan can be used to pay for qualified expenses at private colleges, public universities, community colleges, graduate schools, and trade schools. Also included are tuition and fee expenses for elementary or secondary public, private or religious school. Nearly every state offers at least one type of a 529 savings plan. You can invest in any state's 529 plan, but some states offer tax advantages for residents.

Disadvantages of 529 Plan

While there are many advantages to this plan there are also some disadvantages.

1. Withdrawals if not done correctly can trigger a IRS penalty. The IRS rules on withdrawal are very specific to education related expenses, on what's allowed and what is not. You must use the funds for a qualified educational expense, else you will owe taxes on the withdrawal along with a 10% penalty. Qualified education expenses include tuition and fees, room and board as well as textbooks. They may also include other expenses for attending college such as a computer and software used primarily for the classroom

2. Investment choices are limited by the institution offering the plan. Each state 529 plan is wrapped in the state level statue of limitations , so each plan might offer something different from an investment standpoint.

3. The investment fees charged by institution can be higher for the investment choices compared to regular brokerage firm mutual funds

4. Fafsa and 529s dont go along well. All the money you have saved for the beneficiaries will count against them for the FAFSA calculations

Advantages of 529 Plan

1. The most obvious one is the Federal Tax Breaks. You won’t pay taxes on 529 plan earnings, provided you use the money for qualified higher education expenses, vocational school, K-12 tuition or apprenticeship fees or expenses.

2. No Income Ceiling. Unlike some other educational savings account, there is no income ceiling on who can have a 529 plan. You can qualify for the 529 plan irrespective of your income.

3. Flexibility : You can use the plan withdrawal towards lots of educational expenses and not just limited to college tuitions.

4. You are free to change investments at will in most of the 529 plans, and hence have the ability to have more control over the investments.

In Totality, 529 plan is a great vehicle to invest money now, which can be withdrawn tax free towards your beneficiaries tuition expenses. Most of the investment firms and banks offer the 529 plan as part of their portfolio, and you can invest as little or as much as you would like towards that goal.

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