The U.S. government has created a number of different savings accounts to encourage individuals to put money aside for specific purposes, including retirement, healthcare costs, and education. Named after the section in the Internal Revenue Service code that created this mechanism, 529 plans offer tax advantages for those looking to dedicate funds for their child’s educational costs.
While they were initially designed to help individuals and families save for college, 529 plans can now be used for additional expenses, including K-12 tuition and costs associated with trade schools, among other options.
What are 529 Plans?
Also known as Qualified Tuition Programs, 529s are investment vehicles designed to promote college savings.
Similar to Roth retirement accounts, contributions to 529s are made with after-tax income and then grow tax-free. In other words, the profits you make through the years via these investments can be withdrawn and spent tax-free, as long as they go towards qualified educational expenses.
Qualified expenses are more than just tuition at colleges; the funds can also be spent on room and board, books, computers, and even student loan repayments (this last item is capped at $10,000).
In addition, qualified expenses can also include K-12 tuition and costs related to attending trade schools, certain apprenticeships that are registered with the U.S. Department of Labor, some Gap Year programs, and studying at qualified international universities.
How Can You Open a 529 Account?
Individuals wishing to open a 529 can do so either directly with a state agency or a brokerage. Other than Wyoming, every other U.S. state and the District of Columbia offer 529 plans.
Some states even offer tax deductions on contributions to state residents, though this varies by state usually requires .
The methods in which the monies are invested also depend upon where you open your account. Though you will have choices depending on the level of risk you wish you pursue, your options are limited to the different vehicles that the specific state or brokerage offers.
Upon opening an account, the individual will designate a beneficiary for whom the funds will be used. The ownership of the account does not transfer to the beneficiary, even when they reach the age of 18.
Importantly, the beneficiary can change during the lifetime of the account. Some children may not need to draw upon the money in the 529 account, perhaps because they will receive a scholarship or pursue other non-educational options.
Pre-Paid Tuition Plans
In addition to saving money for future educational uses, some states also offer a pre-paid tuition plan. These plans allow you to lock in current tuition rates at public schools within these states, shielding you from rising prices.
This money can generally only be used for tuition purposes, however, and does not include room and board, books, or other expenses related to higher education.
Pre-paid tuition plans are not offered by every state, and you almost always need to be a resident of the state to qualify. Here’s another downside: if your child (or other beneficiary) does not utilize the funds in the pre-paid plan, most states will only allow you to withdraw the money that has been contributed to the plan without any of the interest earned. There also may be a penalty for withdrawing these funds.
How Can a 529 Help You Save for College
One of the best perks of a 529 is that it will help you to create the processes required for saving money. Having a dedicated account that is specifically geared towards putting money aside for future purposes will make it more likely that you will do this on a regular basis. Regardless of how you manage your finances, knowing that there is an account open can encourage you to make monthly contributions.
Your family can also send money to these accounts, a good option for grandparents who are looking to help the next generation pursue their future ambitions. Even small monthly contributions will add up over time, and will also allow you to take advantage of the benefits of compound interest.
For instance, let us say you decide to open a 529 account with an initial investment of $500 when your daughter begins kindergarten. You decide to make $100 contributions every month to your account, which earns a return of 7% annually. By the time your daughter graduates from high school thirteen years later, you will have over $25,000 in your 529 to pay for her educational expenses.
You can experiment with different investments, interest rates, and monthly contributions using TipRanks’ compound interest calculator to understand how these different factors will influence your overall savings.
Here’s one other item to consider: This year, a new law has come into effect, which allows up to $35,000 in unused 529 account funds to be rolled over into a Roth IRA, tax-free and without penalty. To qualify the 529 account must have existed for 15 years, and the beneficiary of the 529 must also be the owner of the Roth IRA.
This law is still in its infancy, and its implementation may differ by state. That being said, it can help alleviate any concerns that the tax advantages of the 529 will go to waste if the funds are not used for educational purposes.
Conclusion: Saving for the Future
There are many reasons to prioritize investing and saving your money. Most would agree that educational goals are worthy pursuits, and even if you do not know what the future holds for your child, it is a reasonable assumption that they will have aspirations that require educational costs.
Taking advantage of a 529 plan can help you to plan to support these scholastic ambitions by offering a tax-advantaged savings and investment opportunity. Aside from the tax benefits, a 529 will condition you to the idea of making regular contributions to a fund designed for these future educational needs.
There are many hopes and dreams parents have for their children. Helping them reach theirs is at the top of the list.
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