Have you seen how fast these kids grow? Today it’s daycare, tomorrow it’s college. If you haven’t already started saving for your kid’s college education, you’ll have no excuse after reading this article. We’ve collected information on the basics of what a 529 plan is and how to make it work for you (and your little graduate-to-be).
The 411 on the 529
A 529 college savings plan is an investment account that is specifically designed to help you start saving for a child’s college education. These plans are typically managed by an administrator or professional investment manager and are open to investment – by family, friends or anyone else who’s feeling generous. While the money that you put into a 529 plan is not tax deductible, any gains that the investments make and the distributions that are taken out of the 529 and used to pay for college are tax free. Each plan has a beneficiary (the child) who will be able to spend the invested funds on qualified expenses which include tuition, fees, books, supplies / equipment and related expenses for study at any accredited college, university or vocational school in the U.S. (and even some foreign universities). The money can also be used for room and board as long as the child is at least a half-time student.
There are two types of 529 plans: a standard savings plan and a prepaid plan. Standard savings plans are very similar to other tax protected investment vehicles that you might be familiar with (like a 401K or IRA). Those accounts offer tax advantages for your retirement nest egg, while a 529 savings plan offers tax advantages for the money that’s been saved for college. Managing the money that’s invested in these types of account is similar – your investment manager will typically provide you with a number of options for investing the savings. Most commonly, these options consist of different bundles of mutual funds.
In addition to the 529 savings plan, there is also the 529 prepaid plan. The prepaid plan is very different (and more interesting, if you ask us) from the standard savings plan. The prepaid plan allow you to purchase college credits at today’s prices and use them at a later date when your little genius goes to college. If you consider the average rate at which tuition increases, this starts to sound like a really good idea. Prepaid plans are typically provided by the state you live in, and different states are frequently adding or adjusting their prepaid plans. Finally, there are some colleges / universities which provide 529 plans directly. Just be careful when choosing a plan like this, since you may be locked into sending junior to the specific group of colleges / universities offering the plan.
State of Uncertainty
Make sure that you take a look at your state-sponsored 529 plans before you choose a plan. Just because you choose a 529 plan in your state (or another state), doesn’t mean that your children will be limited to schools in that state when they’re applying to colleges. Money from any state-sponsored plan can be used to to pay for a school out of state. But there’s another area where the state-sponsored 529 plans are important. As we said earlier your investment gains and distributions are protected from federal taxes, but there may be significant state tax advantages to choosing a 529 plan administrated by your state. If you can avoid state and federal taxes when growing and ultimately spending your 529 savings, then you’ll get the maximum tax advantage possible.
At this point, hopefully you’re starting to form an opinion about which type of 529 plan will work best for you. To see details on which plans are available in your state you can check this page on savingforcollege.com, which has a break-down of all of the different state-sponsored 529 plans.
Financial Aid Impact
If you’re thinking about how 529 savings might impact your child’s ability to get a scholarship or financial aid, then we applaud you for being so forward thinking. In previous years, the presence of a large 529 plan would have had an adverse effect on the beneficiary’s ability to receive financial aid. However, in 2006 a law was passed that prevents a 529 account from being treated as a student asset on a FAFSA financial aid application filed by a dependent student. This means a custodial 529 will no longer be subject to an assessment rate when calculating financial aid eligibility. In fact, it shouldn’t be included on the FAFSA at all. There are some additional details to be mindful of here though, so read on to the next section.
So you’ve read all the way through this article and it really got your juices flowing. You’re in the mood for some more, right? Well the brainiacs at Yale wrote a very helpful article that lays out additional details in a fairly easy to read document posted here. It outlines some of the grittier details associated with 529 plans including all of the financial aid implications, penalties associated with taking unqualified withdrawals and other captivating tidbits. Hopefully you take all this information to the bank and your little one will spend their 529 savings on tuition at an Ivy League school, like Yale. Tell them Cribsters sent you!