What's The Deal With 529 College Savings Plans?

Many parents think about saving for their children's college tuition. We're flashing back to this post on 529 college savings plan. Read on for great info!

Let’s face it . . . raising kids today is an expensive affair. Making sure they have adequate food, shelter, and clothing may sound simple. But as we all know prices continue to soar at the pump, the grocery store, and so forth. Kids engage in activities that require paying fees as well as equipment or uniform costs. They may need braces or other expensive medical care. And the list goes on and on.

On top of everything else, the thought of trying to save money for your kids’ college educations can be daunting. Sometimes, parents may still be repaying their own student loans. Or, trying to save something for retirement.

The purpose of this post is to discuss the basics of 529 College Savings Plans that can help parents pave the way for their children’s educational journey. In future posts, I will cover the benefits in greater detail, and things to consider before participating in such plans.

Why save for college?

College is an investment in your child’s future. The gift of a college education can open doors to many opportunities for kids. Saving a little at a time can make a big difference when it matters. With the cost of a college education continuing to rise, the key is to start saving early and regularly (just like any other savings goal).

And consider that saving for college now eliminates (or at least reduces) reliance on other student aid in the future, particularly loans. While many parents and students rely primarily on student loans to finance an education, studies show that large student loan debt can cripple a borrower’s future financial goals like buying a home or starting a family. In addition, defaults on student loan repayment is at an all-time high today.

What is a 529 Plan?

A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code.

A significant benefit is all withdrawals from 529 plans for qualified education expenses will remain free from federal income tax. Many states mirror the federal tax advantages for 529 plans by offering state tax-deferred growth and tax-free withdrawals for qualified college expenses.

Types of 529 Plans

There are two types of 529 plans: prepaid tuition plans and savings plans.

Prepaid Tuition Plans

Prepaid Tuition Plans (sometimes called guaranteed savings plans) allow for the pre-purchase of tuition based on today's rates which is then paid out at the future cost when the beneficiary is in college. Performance is often based upon tuition inflation. Prepaid plans may be administered by states or higher education institutions.

Savings Plans

These plans are different in that your account earnings are based upon the market performance of the underlying investments, which typically consist of mutual funds. Savings plans may only be administered by states. Most 529 savings plans offer a variety of age-based investment options so the investments become more conservative as the beneficiary gets closer to college-age. They also offer risk-based investment options where the underlying investments remain in the same fund regardless of the age of the beneficiary. In addition, many savings plans offer an FDIC/NCUA insured, money market or guaranteed option designed to protect an investor's principal while providing for some investment growth. Others may offer investments in certificates of deposit.

State Plans

Each state that offers a 529 plan determines how its plan is structured and which investment options are offered. While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as a state tax deduction, a matching grant, and scholarship opportunities, protection from creditors and exemption from state financial aid calculations, for investors who invest in 529 plans offered by the state where parents live. Click here to Compare 529 Plans by State (from CSPL or College Savings Plans Network).

529 plan restrictions

Withdrawal restrictions apply to both college savings plans and pre-paid tuition plans. With limited exceptions, you can only withdraw money that you invest in a 529 plan for eligible college expenses without incurring taxes and penalties. In addition, participants in college savings plans have limited investment options and are not permitted to switch freely among available investment options. Under current tax law, an account holder is only permitted to change his or her investment option one time per year. Additional limitations will likely apply to any 529 plan you may be considering. Before you invest in a 529 plan, you should read the plan’s offer information to make sure you fully understand and are comfortable with any plan limitations.

Will a 529 plan affect financial aid eligibility?

While each educational institution may treat assets held in a 529 plan differently, investing in a 529 plan will generally reduce a student’s eligibility to participate in need-based financial aid. Assets held in pre-paid tuition plans and college savings plans will be treated as parental assets in the calculation of the expected family contribution toward higher education costs.

In the next two posts, I’ll highlight the numerous benefits related to 529 College Savings Plans and things to consider before investing. Want to learn more about Student Loans? Give us a call at 888.577.2227 or visit our website. We can help you understand your options with student loans and make a plan for the future.

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By Barbara Miller