Nearly every family relies on some type of financial aid to pay for their teen’s higher education. Loans, grants, and scholarships comprise most financial aid packages, but applying for these aid options typically occurs when your student is ready to graduate high school. A 529 savings plan is a way for proactive parents to save for higher education long before their teen starts thinking about college—in fact, parents can open one of these accounts before their child even enters grade school. And parents aren’t the only ones who can open these accounts for a designated student. Anyone who’s 18 or older with a Social Security number can open an account for themselves or someone else. What a great gift from a grandparent, aunt, uncle, or godparent!
What is a 529 college savings plan?
A 529 plan is a tax-advantaged savings account specifically for education. Originally created just for post-secondary schooling, these accounts can also now be used for K–12 expenses. Funds in these accounts can cover a wide range of education-related costs—everything from textbooks to room and board to tools for attending trade school. There are two common types of 529 plans:
- Educational savings plans: These are similar to a standard savings account. The difference is in how they’re taxed. These plans are tax-deferred, and withdrawals are tax-free if the funds are used for qualified education expenses.
- Prepaid tuition plans: This type of plan is a way of paying future tuition expenses at a current rate—essentially “locking in” tuition at a lower cost. Some prepaid tuition plans restrict which colleges they may be used for, so be sure to inquire with schools when exploring higher education financial aid and funding options.
Educational savings plans can also be used for:
- K–12 tuition and fees for participating schools
- Apprenticeship program tuition, fees, and materials
- Student loan repayments
- Computers and other technology needs while enrolled in school
- Accessibility education-related equipment for students with disabilities
Related: How to Avoid College Debt Before It Starts: Savings Tips for Parents
Rules and regulations
529 plans are administered by all 50 states and the District of Columbia. The rules and regulations, including taxation, are different for these accounts in each state. You can contribute any amount to your beneficiary’s 529 account each year, but be aware that some states have a cap on how much you can contribute overall. Even if the beneficiary takes a gap year or decides not to go straight to college after high school, they can still utilize their 529 account when they’re ready to attend; there’s no time limit on when it can be used.
How to open a 529 plan
A broker or financial advisor can handle the process of opening an account for you and your student. These professionals act as intermediaries between you, the client, and the state. They can help interpret the financial jargon that comes with opening a new financial account and, of course, answer any questions you may have.
Related: 4 Tips for Families to Maximize College Affordability
Benefits of 529 plans
There’s no question about it—college is expensive. The most obvious benefit to a 529 plan is the security of knowing your student will be set for college. While money in a 529 plan can only be used for education-related expenses, this is a broad category. If you’re worried about paying for things like books or a new computer for your child, you can rest a little easier. Think of it as an extra financial cushion that can cover a wide range of necessities. However, there are tons of other benefits:
- Ease of setup: A trusted financial advisor can take care of setting up and managing the account for you. They can also advise you on when to add to the account, when to withdraw, and any other relevant issues. You’ll receive a monthly statement just as you would with a standard savings account, so you can track your deposits and withdrawals throughout the life of the plan.
- Flexibility: There are 529 college savings plans available regardless of which state you live in. However, be aware that the rules for these accounts are different for each state. If you move, speak with a financial advisor in your new state about your account and how it may change.
- Tax-free withdrawals: Unlike savings bonds or other types of funding, there are no federal income tax implications for withdrawing money from a 529 account if you’re using the funds for education-related expenses. Some states don’t even tax withdrawals; this is something to ask your financial advisor.
- Tax-free contributions: There are no fees or tax-related expenses for depositing funds into this type of account.
Drawbacks to 529 plans
There’s no “one size fits all” approach to 529 accounts. Each state has their own rules and regulations, so depending on where you live, your account might be different from the account of a friend or relative in another state. You need to be prepared for the guidelines that come attached. As stated before, 529 plans are only for education-related expenses, so if you’re short on cash or an unforeseen emergency pops up, you can’t dip into this account to cover those costs.
Related: How to Pay for College When Your 529 Plan Takes a Hit
College is expensive, but there are ways to start saving for education long before your student starts looking at schools or filling out applications. A 529 plan can give you some peace of mind and the extra financial resources to help them reach their educational goals.
In the end, you may find yourself with more college savings than you expect. Come back to our article on Smart Things You Should Do With Excess 529 Funds if you’re one of the lucky ones!