Is a 529 College Savings Plan Right for You?

If you have kids or grandkids running around, one thought that might have crossed your mind is paying for their college education. After all, education is an important factor in their long-term success and stability. It is also increasingly expensive. The National Center for Education Statistics reports that the cost of college has increased from $4,885 in 1985 to $24,623 in 2018! Parents and grandparents increasingly want to give their offspring a helping hand with this expense. One of the best ways to do that is with a 529 plan.

529 Basics

At its core, a 529 plan is simply an investment account, similar to your Brokerage or Roth IRA. The idea is you contribute to the account, invest the funds, and let the money grow. Once the beneficiary is ready to start college you can begin withdrawing the money for them to use. A key consideration here is that while the account is earmarked for a certain beneficiary, you retain control of the account. If the original beneficiary does not need the money, you have the ability to name a new account beneficiary.

529 Plans are also unique in that they are administered by the individual states, with each state having its own version. Most plans are open to everyone, so you can open a 529 plan in a state even if you have never set foot there! If you live in a state that has a state income tax, then you might need to pick your state’s plan to ensure you get any state tax benefit for making a contribution. If your state has no income tax, then you can pick the best plan from the available options. Generally, you want to look for 529 plans with the best investment choices and the lowest fees. Follow this link to compare 529 plans by state.

529 Plans and Taxes

The advantage of using a 529 plan comes from its tax treatment. 529 plans are funded with after-tax money, which means you don’t get a tax break for contributing to one at the federal level (although some states offer a tax credit for doing so). However, when the money is invested and grows, that growth is all tax-free IF used for qualified educational purposes. There is a 10% penalty imposed on earnings that you withdraw for a non-qualified purpose, in addition to the regular income tax you pay on the gain. This tax treatment is similar to the way a Roth IRA functions.

When to Use a 529 Plan

Many young parents who are considering starting a 529 plan may be getting ahead of themselves. In the early years, the primary focus should be on mastering the fundamentals before moving on to other goals. While education is important, having enough savings in the bank for an emergency and maxing out your retirement accounts should have a higher priority. To learn more about the Fundamentals of Financial Fitness, click here.

Bringing it Together

Over the last few decades, the cost of college has increased dramatically. 529 plans offer a tax-advantaged way to set funds aside and let them grow tax-free. If used correctly, a 529 plan can be a fantastic way to pay for a child’s education. However, it should not be prioritized over financial fundamentals such as adequate savings and fully funded retirement contributions.

To learn more about 529 plans or college planning in general, click here or click the “schedule a call” button on the right side of the screen. We look forward to visiting with you about your specific situation.

529 plans are invested in a combination of stocks and bonds, which will experience volatility over time. Click here to read more about how to handle volatility and the importance of staying the course.