If you have children—even young ones—you’re probably already thinking about saving for their college education. One popular and tax-advantaged way to start building a college fund is through a 529 plan. That’s a specialized savings account designed to help families save for educational expenses, from K-12 to college and beyond. Here are some of the basics to know.
What is a 529 Plan?
A 529 plan, named after Section 529 of the Internal Revenue Code (yawn… those IRS folks aren’t really known for their creativity in naming things!), is a tax-advantaged savings plan specifically designed for educational expenses. That can include tuition, fees, books, room and board, and other costs. There are two primary types: the 529 College Savings Plan and the 529 Prepaid Tuition Plan. Each works slightly differently.
1. 529 college savings plan
This type of plan works like a traditional investment account. You contribute after-tax dollars to the plan, which goes into a variety of investment options, like mutual funds. The investments have the potential to grow over time, and the earnings can be withdrawn tax-free if you use them for qualified educational expenses. They can be used at any eligible institution, including most colleges and universities in the United States, and even some international ones.
2. 529 prepaid tuition plan
Prepaid tuition plans, available in a limited number of states, allow you to purchase future tuition credits at today’s prices. That way, you’re protected against rising tuition costs. The funds can be used at in-state public colleges and universities, and some plans also allow you to use them at private or out-of-state institutions.
How does it work?
1. Open a 529 account
First, you need to open a 529 account. You can usually do this through your state’s version of the plan or choose a different state’s plan if it offers better benefits or lower fees. You can open a 529 account for your child, grandchild, or even for yourself if you plan to return to school.
2. Contribute funds
You put money into the 529 account, either as a lump sum or through regular contributions. Some plans have minimum contribution requirements, while others let you contribute as little as $25 or $50 per month.
3. Investment options
If you’ve chosen a 529 College Savings Plan, your contributions will be invested in various financial instruments, like stocks or bonds. The plan’s performance will of course affect the account’s growth over time—hopefully in a positive way!
4. Tax advantages
One of the primary benefits of a 529 is the tax advantage. While contributions are made with after-tax dollars, any earnings in the account grow tax-deferred. More importantly, qualified withdrawals for educational expenses are entirely tax-free.
5. Qualified expenses
You can use the funds for a variety of qualified educational expenses, which typically include tuition, fees, books, supplies, and even room and board. Recent changes to tax laws have also allowed 529 funds to be used for K-12 education expenses.
529 plans are very flexible. If the beneficiary doesn’t use all the funds for their education, then you can change the beneficiary to another family member. The funds can also be saved for graduate school or withdrawn for non-educational purposes, though you may have to pay taxes and penalties.
You can access your 529 funds at any eligible educational institution, not just those within your state.
The bottom line
A 529 plan is a really valuable tool if you’re looking for an efficient way to save for educational expenses. Whether you opt for the 529 College Savings Plan or the 529 Prepaid Tuition Plan, these accounts offer tax advantages, flexibility, and the opportunity to help your loved ones achieve their educational goals without incurring excessive debt.