What Is a 529 Plan and Why Do You Need One?

Co-founder, GiveCollege.com

Last Updated: Jan 18, 2013

Saving for college can be a daunting task many parents put off until the last minute, resulting in the need to take out massive, sometimes crippling student loans. On the other hand, families that take the time to plan early find it to be a relatively painless process with big rewards at the end!

Although the most common vehicle used to save for college is a 529 college savings plan, only 62% of families are familiar with them and the financial benefits of saving early. For example, did you know . . .

  • If you put $5,000 in a 529 college savings plan during the first year of your baby's life, it could be worth over $17,000 (tax free!) when that child goes to college.
  • If you wait eight years to put the same $5,000 in a 529 college savings plan it might only be worth $10,000 when the child goes to college.

The earlier you start, the more you can save!

What is a 529 college savings plan?

A 529 plan is a tax-free college savings vehicle and is very similar to a Roth IRA, if you are familiar with those. If not, don't worry—here are the basics:

  • You (and/or your family and friends) make deposits in to a 529 college savings plan set up for your child.
  • Watch your money grow over time.
  • Use that money to pay for college.
  • Enjoy the tax-free benefits!

How to select the right 529 college savings plan

Opening a 529 college savings plan may seem overwhelming at first, but selecting the right plan is much simpler than it appears. Unless you are going to purchase a 529 college savings plan through a financial planner (see step #1), you will need to purchase what is called a direct sold savings program or direct sold 529 plan.

Here are the main things you should consider when selecting the right plan for your family:

  • Financial planners. If you have a financial planner, call him or her; 529 plans should be well within his or her realm of expertise. If you do not have a financial planner, keep reading!
  • State tax benefits. Some states offer tax benefits and/or matching programs for residents when they open a 529 college savings plan sponsored by the state they live in. For example, California has no tax benefits for California residents opening plans administered by the state of California, so there is no direct benefit to choosing a 529 plan administered by the state of California versus one administered by another state. However, Connecticut offers state tax deductions for residents who open and contribute to a Connecticut state-sponsored plan such as CHET. Before opening a 529 college savings plan, you should check the tax benefits in your state.
  • Check in with the experts. Each fall, Morningstar names its top 529 plans. We found this a good place to start in gathering information to make your selection.
  • Minimum starting contributions. Each 529 college savings plan has a requirement for a minimum initial contribution, which can range from $0 to thousands of dollars. If budget is an issue for your family, opening a plan with a small starting contribution requirement can help you get started saving faster! Again, you can use a 529 plan comparison tool to research minimum starting contributions and subsequent contributions discussed below.
  • Minimum subsequent contributions. Each 529 college savings plan also has a minimum requirement for subsequent contributions. Again, if your family is on a budget, choosing a plan with a small subsequent contribution requirement will allow you to continue to add to your 529 college savings plan at regular intervals, which is the best way to help your savings grow and help you pay for college! Depositing just $25 per month for 18 years will result in savings of over $13,000 when your child goes to college.
  • Fees: 529 plans have different fees, and you should compare the plans you are considering to make sure you are comfortable with what you are getting for your money. Savingsforcollege.com offers a great way to compare fees and other features by plan. The less you pay in fees, the more you save for college.

How to open a 529 college savings plan

Once you have selected the plan you are going to use, it is fairly simple to open the account and can usually be done online. You will need the following information to open the account:

  • Account owner. The account owner is the person who opens the account (usually a parent or grandparent) and the person who maintains control of the funds in the account. You will need the owner’s social security number to open the plan.
  • Beneficiary. The beneficiary will be your college-bound child and the funds accumulated in the plan will be designated for the education of the beneficiary. At any time, the owner of the account can change the beneficiary to another member of the family without penalty (subject to IRS guidelines). You will need the beneficiary’s social security number to open the plan.
  • You can open the account either online or by calling the toll-free number for the plan. Your account will be open in minutes.

How to save money for your 529 college savings plan

Now, for the obvious question in everyone's mind: How do you save money for your 529 plan? Believe it or not, it is not as difficult as you think! Here are some easy ways:

  • Pack your lunch instead of eating out at work.
  • Plan free family activities such as a day at the park or family game night.
  • Shop smart at the grocery store by planning your meals and putting your grocery list together ahead of time (and sticking to it!). Impulse shopping is the biggest reason for over spending.
  • Set up automatic monthly deposits into your 529 plan. This will ensure you set aside money and don’t spend it on other things. If it’s a direct deposit, you won’t even miss it!
  • Save what you save! Try to implement a couple of these money saving tips and put whatever you save into your child's 529 college savings plan—it will more than pay off!
  • Ditch the unnecessary gifts. Let's be real: between hand-me-downs and family members who want to spoil your child, you probably don't need any more toys than you already have. Ask your friends and family to contribute to your child's 529 college savings plan in lieu of a traditional gift during that first year. Whatever denomination they chose to give will likely double by the time your child goes to college, and the growth will be tax-free when used for college! Contributions to a 529 plan are subject to gift tax exemption in the event Grandma and/or Grandpa want to make a large contribution.

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