A 529 plan is among the best ways to save for college without incurring student debt as you enter adulthood. 529 plans offer an unparalleled amount of flexibility and tax benefits compared to a traditional savings account, where money does very little for you.
Imagine watching your money grow tax-free for 18 to 20 years while you save for your future education. Imagine the feeling of knowing that you will have accumulated savings that will be available to pay for your future education without having to pay any taxes! That’s the real beauty of a 529 plan and why they are often referred to by the phrase “Work smarter, not harder.”
It is important to note that a 529 plan is an investment account that is designed to be used to pay for higher education expenses. A 529 account is owned by one person (usually the child’s parents or grandparents) but benefits the child or the beneficiary of the 529 account. While it is usually a case of parents or grandparents setting up the account for their children or grandchildren, there are a variety of other potential beneficiaries, including siblings, cousins, spouses, and yourself. Also, if a situation changes and the child or beneficiary cannot use the funds, you can change the beneficiary without any difficulties.
The name 529 Plan comes from the section of tax law under which these plans are governed, so you can see this is something that is very serious. Each state operates its own plan; nearly all states have at least one. Even better, you do not have to use your home state’s plan or even have your student attend a school in your home state, which means geography is not that big of a deal.
One of the biggest reasons why people love 529 Plans is because of taxes, or more accurately, the ability to avoid taxes on the funds that they have placed in their 529 Plan Accounts. Funds deposited into 529 Plans can be invested into various investment vehicles, such as mutual funds and index funds, and over time, those investments compound. And when those investments are redeemed for qualified educational expenses, you do not have to pay taxes on any of the income generated from your 529 Plan. This is a huge benefit.
If you have invested in a typical investment account, you will pay taxes on any growth you have experienced when you redeem the investment account. However, with a 529 Plan, you will not pay taxes on that growth. It is the same amount of growth as you would have received in a typical investment account; however, you will have less taxes to pay. It’s an easy concept to understand.
You may contribute as much as you want to your 529 Plan account in any given year, there are caps on the maximum amount of money that can remain in your account. The maximum amounts are determined based on the individual state and relate to projected costs for education. Some states allow account holders to hold large sums in the hundreds of thousands of dollars; in most instances, that would be enough for the majority of college paths.
Many states offer an additional incentive: In addition to offering taxpayers a state income tax deduction for the contributions, the state also allows taxpayers to withdraw the funds tax-free from the account if they use them to pay for qualified education expenses. While this is not a windfall amount of money, every penny counts when it comes to saving money.
Every penny spent on college tuition can be covered with these accounts, as well as every book, computer, and room and board that you will need during college. You are not limited to using your 529 plan accounts for just college expenses. You also have the flexibility to use a portion of your contributions towards paying qualified K–12 tuition, qualified apprenticeship programs, and paying off your student loans. The list of qualified expenses has grown over the years, and the rules regarding how you can access your funds have also become more flexible.
If you take funds out of your account to pay for non-educational related expenses, you will be subject to income taxes and penalties on the earnings portion of your investment. This can quickly result in a financial loss. You will not suffer any penalties on your original contributions, but you will be penalised for any earnings that you withdraw from your account. Therefore, the only way that these accounts work properly is by depositing and using your money for qualified education expenses only.
The possibility of your child receiving a scholarship and not needing the full amount is a great opportunity for you! Withdrawing all or a portion of your contribution to a child’s education account is possible at this point without penalty. However, if you withdraw money from a child’s educational account, you may still be responsible for paying taxes on your earnings.
It’s best to make contributions to a child’s college savings account as early as possible. A child’s college account will have almost 18 years to grow. Contributions made in early years are usually what help to create wealth over time.
Consistency is important in building long-term wealth. In general, if you can make regular contributions (monthly, if possible), you will end up with more money than if you only made occasional deposits. Think of it this way: every month you make a contribution to a child’s education account, you are giving a gift to your future self.
Investments within a 529 plan should undergo changes as the time until college approaches. Early in the college savings process (i.e., when there is a large time frame until college), it is usually advisable to take on more investments; however as the date gets closer to enrollment, it may be a better option to decrease risk and protect your investment up to this point. Certain 529 plans allow you to do this automatically, utilising age-based strategies.
So while 529 plans may not seem very glamorous or exciting on a daily basis, they build your odds over the long term. Rather than having to deal with overwhelming amounts of debt after college (and with the associated competency challenges), you will have greater control over the decisions that need to be made regarding further education (options), as well as less potential regrets over your financial investments.
Overall, using a 529 plan may be the best way to save money for college.
