If you’ve been following the cost of higher education, you know that it’s on a continuous ascent. Since every financial planner asks their clients how important it is to save for their children’s education, you might conclude that most parents are saving for education, but that’s not the case.
According to Statista, only 20 percent of parents age 30–59 were saving for their children’s college education in 2017. Other than having a savings account set aside for their children’s future education, many parents don’t know of any options available to them specifically for saving for college.
There is another choice for parents to set aside funds for their children’s future college costs. It’s not a household financial number like 401(k), but it’s been an excellent tool for many parents. It’s called a 529 plan.
The 529 plan is named after Section 529 of the Internal Revenue Code and is a college savings plan offering tax and financial aid benefits. Although contributions to the plan aren’t deductible, the earnings in a 529 plan are not subject to federal taxes. In addition to the federal tax savings, over 30 states currently offer a partial or full tax deduction or credit for contributions made to a 529 plan. The IRS also allows tax-free withdrawals of up to $10,000 per year, per child (beneficiary) to pay for tuition expenses at private, public, and religious K-12 schools.
Once you put money into a 529 plan, it’s still yours, and you can always withdraw it for any purpose. However, the earnings from the investments you selected inside the plan will be subject to ordinary income taxes and a 10% penalty, with some exceptions.
Just about every state has at least one 529 plan available, and the money you invest in your plan can be used to pay for college costs at any qualified college nationwide, not just the state in which you reside. 529 plans will vary from state-to-state since it’s up to each state to decide what their plan will look like. You can live in one state and enroll in a plan from another state if you choose.
Your funds can be used to pay for qualified education expenses at eligible colleges and post-secondary educational institutions, including:
- Tuition fees
- Sometimes room and board
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There are two types of 529 plans: the College Savings Plan and the Prepaid Tuition Plan.
- College Savings Plans work very similarly to a Roth IRA by investing your contributions in mutual funds or similar investments. Like any investment, your account can fluctuate in value based on the performance of the investments you select.
- Prepaid Tuition Plans allow you to prepay all or part of in-state public college education costs. Your savings can also be used at over 250 out-of-state private colleges.
One of the main reasons people don’t utilize a 529 plan is they don’t know how to get started. They don’t know how to put money in it, who to talk to about it, what information they need, or if they need to go to a bank to start one.
The good news is that opening a 529 account is pretty straightforward. Here are the five steps you need to take to get started:
1. Select a plan
This is perhaps the most challenging part for many people since there are over 100 savings and prepaid 529 plans available.
You’ll first need to decide if you want a College Savings Plan or a Prepaid Tuition Plan. If you can’t decide, you can open one of each and split your contributions between them.
You’ll next need to choose either an in-state or out-of-state plan. If you have a state tax benefit, it’s usually to your advantage to select the in-state plan.
Some of the highest-rated 529 plans are:
- New York’s 529 College Savings Plan – Direct Plan
- U. Fund College Investing Plan (Massachusetts)
- UNIQUE College Investing Plan (New Hampshire)
- Ohio’s 529 Plan, CollegeAdvantage
- Bright Start Direct-Sold College Savings Program (Illinois)
2. Visit the site
This is where you’ll find out what the plan requires in terms of documentation. Each state requires different information to open an account, but you’ll need - at a minimum - this information:
- Personal information, including your address, date of birth, and social security number
- Beneficiary information, including their birth date and social security number
Since an account typically has only one owner, it’s a good idea to name a successor account owner, a person to whom ownership is transferred in the event of the original owner's death.
3. Open the account
To open the account, you can complete a physical application and mail it in or download one from the plan website. Most plans let you complete everything online and submit funds into your 529 plan directly from your checking account.
4. Choose the investments
The complexity of this step can depend on your investment experience and preferences. Most account owners choose an age-based-portfolio corresponding to the beneficiary's age and are then finished with this part of the process.
Others choose to build their own investment mix by investing in individual mutual funds, stocks, or bonds. If you’re unsure which to select, you can always select the simple age-based option and change it later.
5. Submit the application and deposit funds
Now that you’ve completed the forms and made your choices, you can put a stamp on the envelope or hit the send button to get your plan approved. You can fund the account immediately by providing your banking information or mail a check.
Using a 529 plan to fund your children’s education is a tax-advantaged strategy that you can start on your own or with the help of a financial advisor that is very familiar with 529 plans. Like any financial tool, it’s only valuable when it’s used.
Having grown up in upstate New York, Bob Phillips spent over 15 years in the financial services world and has been making freelance writing contributions to blogs and websites since 2007. He resides in North Texas with his wife and Doberman puppy.
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