Is it too early to save for your child’s college?

Recommends 529 savings plan

When planning how to pay for your child’s college education, there are many options to consider. Among these options are 529 college savings plans, which allow you to start saving today to pay for your child’s future college expenses.

In 2022, families paid an average of 20% more for their children’s education than a decade ago. Starting to save for college as early as possible can help you plan ahead and prepare for potential tuition price increases. Before starting a savings plan, it’s important to understand what 529 plans are and how they affect your overall college expenses.

What is a 529 plan?

A 529 plan is a tax-advantaged savings investment vehicle designed to help you pay for the future education expenses of a designated beneficiary. 529 plans, also known as quality education plans, are funded by both states and private organizations.

Contributions to a 529 plan are made using after-tax dollars, so withdrawals are not subject to federal income tax when paying for qualified education expenses later. Depending on your state’s tax laws, your qualified withdrawal may also be exempt from state income tax.

A common myth is that only the beneficiary’s parents can open a 529 account, but this is not true. Anyone 18 or older with a Social Security number or tax identification number can open a 529 plan account for themselves or someone else — including grandparents, aunts and uncles, godparents, and even relatives of the beneficiary.

Types of 529 plans

Depending on the state you live in, there are two types of 529 plans: prepaid education plans and education savings plans.

Prepaid education plans

A prepaid 529 plan allows you to lock in today’s tuition rates for future enrollment at participating colleges. Plan funds can be applied towards up to five years of tuition, which may be a two- or four-year program or a combination of the two. However, most prepaid tuition plans do not cover expenses such as room and board or supplies.

It’s important to note that not all states guarantee that your plan will keep up with rising tuition costs, so you should carefully review your state’s plan before opening to determine if it meets your individual needs.

Pays: Future college education at participating colleges and universities.

If your student chooses to attend a private or out-of-state school, your plan may provide a matching amount to pay for their tuition. Most prepaid plans allow you to transfer the plan to a sibling of the beneficiary if you are below a certain age.

Requirements: Many state-sponsored prepaid plans require that the account holder or beneficiary be a resident of their state when they apply for the plan. Some plans also apply an age limit for the beneficiary.

Education savings plans

Education savings plans allow you to open an investment account to save for the beneficiary’s future college expenses in addition to tuition.

Pays:

  • Participating college, graduate, or apprenticeship program tuition and fees
  • Participating elementary and middle school (K-12) tuition and fees
  • Student loan payments
  • Room and board
  • Books and supplies
  • Computer and internet access for course work during registration
  • Equipment for special needs and accessibility

Requirements: Most education savings plans do not require the account holder or beneficiary to be a resident of their home state.

529 plan fees and expenses

Any fees and expenses charged by the investment plan lower the total return on your investment. Depending on the type of plan and who offers it, the amount you pay may vary. Here are the common types of fees you may be subject to when opening a 529 plan:

Prepaid Education Plans:

  • Registration fee
  • Application fee
  • Ongoing administrative charges

Tuition Savings Plans:

  • Registration fee
  • Application fee
  • Annual account maintenance fee
  • Ongoing program management fees
  • Fixed asset management fees
  • Sales freight fee (charged by broker)
  • Ongoing distribution fees (charged by broker)

How to avoid overpayments: Purchasing a plan through a broker may increase the amount of fees you pay to maintain the account. Consider plans sold directly by your state with no additional brokerage fees.

Some plans may waive fees if you meet specific requirements, such as maintaining a high account balance, enrolling in an automatic contribution plan, or living in the same state that offers the plan, so thoroughly review the plan’s fee structure for potential savings.

How is a 529 taxed?

Qualified education plans are a tax-advantaged way to save for future expenses because your earnings are tax-free when invested in your account. This means that the longer your money is invested, the greater your tax benefit – so it pays to start saving as early as possible.

Contributions: Your state may offer tax incentives for contributing to a 529 plan, such as state income tax deductions or grants. Eligibility for these benefits may vary depending on whether your plan is state or agency funded. Before opening an account, consider consulting a tax advisor about possible state-specific tax benefits.

Excerpts: Generally, withdrawals from 529 accounts used for qualified expenses are not considered taxable income at the federal and sometimes state level.

On the flipside, withdrawals for non-qualified expenses are considered taxable income at the federal and sometimes state level and result in an additional 10% federal tax penalty on any earnings in the account.

There are some situations where you won’t have to pay the 10% withdrawal penalty, such as:

  • The beneficiary dies or becomes disabled
  • The beneficiary receives a tax-free pension
  • The beneficiary receives employer-sponsored educational assistance

Contribution and withdrawal limits

529 plans have limits on contributions and withdrawals from the account.

Contributions: State-sponsored 529 plans limit the amount of contributions per beneficiary to prevent excess funds in the account upon completion of the educational program. Plan limits can range from $235,000 to $550,000, but may vary depending on your individual state tax laws.

Excerpts: There is no specific dollar limit on how much tax-free you can withdraw from a 529 plan each year if you use the funds for qualified college expenses.

However, if you plan to use the funds to pay off student loans, there is a lifetime limit of $10,000 per beneficiary. This means that the remaining funds can be transferred to the beneficiary’s sibling to repay student loans up to their individual lifetime limit.

If you plan to use the funds to pay for K-12 education, there is an annual limit of $10,000. The year in which it exceeds this amount is considered taxable income.

Can you transfer a 529 plan?

Yes, you can transfer a 529 plan to an eligible family member of the beneficiary without tax consequences. This can be done at any time by filling out a form on your plan’s website.

Qualified family members of the beneficiary include:

  • Wife
  • A child, stepchild, adopted child, adopted child, son-in-law, daughter-in-law or descendant
  • Brother, half-brother, sister-in-law or sister-in-law
  • A parent, stepfather, father-in-law or mother-in-law
  • Aunt, uncle or spouse
  • Brother, nephew or spouse
  • First cousin or spouse

It’s important to note that there can only be one beneficiary of a 529 plan at any given time. So families can use a single plan for more than one child, but withdraw money from the account to cover only one child’s eligible expenses.

Patricia Roberts, the gift company’s chief operating officer, says that while it’s possible to use the same plan for multiple children, it’s generally not desirable because most 529 plans are invested in age-based portfolios that take into account the time horizon for the funds to grow. College.

Impact on financial aid eligibility

Finally, any funds in a 529 plan generally reduce how much financial aid is needed to afford college and may change the ability to receive need-based aid.

But that might not be such a bad thing—most financial aid packages include student loans. So higher savings in a 529 can mean your student will incur less student loan debt than if they weren’t in the plan.

“Having a 529 plan is more valuable than relying on a form of assistance that you may or may not receive,” says Roberts. “[Financial aid] often not free money. This is money that should be returned.”

Pros and cons of 529 plans

Saving for college can be a daunting task. However, 529 college savings plans offer families an easy way to start saving money for future expenses. Before opening an account, consider all the pros and cons of the plan.

Additionally, 529 plans are favored by parents for their ability to directly contribute to a child’s education savings using a third-party online platform.

For example, if your child’s birthday is coming up, you can request that loved ones donate directly to their 529 plan using your personal online link. This makes it easier to save for your child’s future college expenses and benefits your child financially in the long run.