What is a 529 plan and how do they work?
Education savings is often part of the financial plans we create. Whether clients are interested in pursuing a masters or doctoral degree, or they want to help fund the college education of their kids and grandkids, navigating how to efficiently save for continuing education costs while maximizing tax savings can often feel like an insurmountable challenge.
Luckily, this doesn’t have to be the case. Although there are several ways to save for the cost of higher education, the 529 Plan is a tool that many investors use to grow their education savings over time.
What is a 529 Plan?
A 529 Plan is an investment account that can be used to save for specific education expenses. Investors contribute after-tax funds to the account, which then are invested depending on your time horizon for needing the funds. Funds in the account grow tax-free, and distributions are tax-free when used for qualifying education costs.
Nearly every state has a 529 Plan, but you don’t only have access to your state’s plan. Investors can choose the plan that best fits their unique needs and goals. However, some states offer additional benefits to residents who open a 529 Plan in their home state, such as waived account fees.
What Can a 529 Plan Be Used For?
A 529 Plan is used for education expenses only. Qualifying expenses include:
- Tuition and fees
- Books and supplies
- Internet access and computers
- Room and board
- Special needs equipment
- Tuition for K-12 private education
- Student loans up to $10,000
Some costs, however, do not qualify. Transportation, for example, is not a qualifying expense. If 529 Plan funds are used on non-qualified expenses, those funds are subject to a 10% tax penalty and income taxes.
Who Can Open a 529 Plan?
The beauty of a 529 Plan is that anyone can open one for anybody. A grandparent or family friend can open one for a newborn, parents can open them for their children, and you could even open one for yourself to pay for continuing your education. The key is that whoever opens the plan must name a plan beneficiary. The funds will then go to that beneficiary for qualified education expenses when they request them.
What If My Children/Grandchildren Don’t Go To College?
In the event that the plan’s beneficiary doesn’t go to college, you have two options:
- Change the beneficiary listed on the plan. This can help you to redirect the funds towards another child who plans to attend college, or another family member who needs the funds for education expenses.
- Eat the penalty. If you still want to give the funds to your child, or whoever the original intended beneficiary is, you may decide that paying the 10% penalty and income tax on the funds is worthwhile. Consult your financial advisor before making this decision!
Remember, anyone can open a 529 Plan and anyone can contribute. So even if you choose to change the beneficiary to someone else, other people can still continue to contribute to the new beneficiary’s education fund.
Finance 101: Prioritize Your Saving
It’s important to remember that, while education savings might be a priority for you and your family, it pays to put your own mask on first. There aren’t loans available for retirement. If you short your long-term savings goals to fund education costs for the next generation, you may be setting yourself up for working for an extended period of time, or for becoming financially reliant on your kids as you age.
If you are on track to meet your retirement goals and decide to move forward with education savings, there are still a few guidelines to consider:
- Don’t overfund your 529 Plan. You don’t want to get penalized if the beneficiary doesn’t use all of the funds, and you choose to withdraw the money for other purposes.
- Remember to reassign the beneficiary if plans change. If your original beneficiary doesn’t use all of your savings, or doesn’t plan to go to college, you can assign your 529 Plan beneficiary to another individual who might be able to use the money on qualified expenses.
- Don’t bypass other goals. Education savings can be a fantastic way to create generational wealth and build a legacy. However, it’s also important to remember that your wealth should help to create the life you want. Whether it’s retirement savings, or another lifestyle goal you want to pursue, make sure to evaluate whether or not that impacts your education savings strategy. Pausing savings, or setting achievable goals that have limits, can help you to continue moving toward other financial milestones you’re excited about.
- Communicate contributions with everyone. If grandparents, parents, and other relatives are contributing to a 529 Plan, it’s important to make sure that everyone knows how much money is going into the account to sidestep over-contributing.
If education saving is part of your financial goals – either for yourself, your children, or your grandchildren – a 529 Plan may be one of the ways you can pursue setting money aside while reaping tax benefits. Always discuss your education savings goals with your financial advisor team to ensure you’re creating a strategy that benefits you and your family in the long run.