Your child(ren)’s education can be an expensive endeavor. With the continually rising cost for furthering education, pre-planning for education can not only provide you with a way to stretch your money through investments, but also provide tax advantages.
This step-by-step guide will explore in depth what a 529 college savings plan is, when you should consider opening one, and the steps you should take to get started.
What Is a 529 College Savings Plan?
A 529 college savings plan is a tax-advantaged way to save money for your child(ren)’s educational expenses. They are run by all states, including the District of Columbia.
As of 2020 the majority of 529 savings plans now allow the funds to be used for K-12 public and private education, apprenticeship programs, and religious school tuition as well.
How Does a 529 College Savings Plan Work?
A 529 college savings plan works to save money for your child(ren)’s future expenses. When you open the account you will be the account owner. The child will be the beneficiary.
It is important to note that the child does not have to be your own. You can set up an account for family and friends, as well as for yourself!
The beneficiary will be the student that receives the funds for their education. As long as you have the personal information of the beneficiary, you can set up an account on their behalf.
You can then begin placing money into the account. The funds that you invest will grow tax-deferred. When the beneficiary uses the funds for a qualified educational expense they will be tax-free. Qualified expenses include supplies, tuition, books, fees, room and board, among other expenses.
What Is the Minimum to Start a 529 Plan?
While each plan is different, there is no set minimum across the board to open or contribute to start a 529 plan. Many plans have a minimum contribution of $15 per month with an initial contribution of $25.
Other plans require a minimum initial investment of thousands of dollars. Be sure to research the plans to determine which is the best choice for your child’s desired goals.
How Much Should I Put in a 529 Plan?
Before you begin saving you should consider how much you would like to put into the 529 savings plan. Consider the education you would like your child to receive and start there.
Most in-state universities charge $165,000 on average. Out of state tuition can run upwards of $260,000. If you prefer to go the private education route it can cost over $325,000. There is no right or wrong amount to save for your child’s future education.
The IRS does not allow contributions to be more than the funds needed for the educational needs of the student. That is why many states cap their 529 plan contributions somewhere between $350,000 and $500,000.
What to Keep in Mind When Having a 529 Plan
When you are looking for an investment vehicle to save for your child’s education, a 529 plan is a great choice. However, you should be aware of a few key advantages, like tax incentives. You should also keep in mind the disadvantages, for instance, how it impacts financial aid.
How Is Financial Aid Affected?
When your child applies for financial aid the family’s entire financial picture is considered. During the application process the 529 plan might increase the Expected Family Contribution (EFC), leading to fewer grants, work-study opportunities, and subsidized loan options.
Are There Tax Incentives?
When you invest in a 529 plan the money grows tax-deferred. As long as the distributions are utilized for qualified educational expenses they will be tax free.
What Happens If the Beneficiary Doesn’t Go to College?
There are three options that you can choose from if the beneficiary of a 529 plan does not go to college. The first is to use the funds for other educational expenses like trade or vocational schools. Most funds are now able to be used for programs abroad and post-secondary training.
If ongoing education does not appeal to the beneficiary you also have the option to change the beneficiary. You can transfer the account two times annually to another beneficiary including a different child or even yourself!
Lastly, the final option is to use the funds for things that are not associated with education. When you use the funds for non-qualified expenses the beneficiary will incur a 10% penalty fee on the earnings as well as income tax obligations.
3 Simple Steps to Open a 529 Savings Plan
Opening a 529 savings plan is not complicated, however you should put in time to do adequate research in the beginning stage. Here are the 3 simple steps that you will follow when you’re ready to open a 529 savings plan.
Step One: Select a Plan
The first step in the process is to find a plan you want to open. You should do your research and shop around. The good news is that there are plans available in every state, and you do not have to use your home state’s option!
Although you should at least consider it because many provide state income tax deductions or credits for contributions to their state’s 529 plans. Residents in the following states can receive income tax breaks when they contribute to any state’s 529 plans: Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania.
When you’re searching for a plan, look at the performance and fees of each option. We’ll explore some of the best options further in this post.
Step Two: Choose Your Beneficiary
Once you have selected the plan you will then need to gather information on your beneficiary. You should have their social security number, birth date, and address if it differs from your own.
Step Three: Create an Account & Start Building Your Plan
Finally you are ready to create an account. You will start by filling out an application that includes your personal information along with the beneficiary’s information. Remember, the beneficiary can change down the road if need be.
Once the application has been approved you can begin depositing money into it. Most plans have options to electronically transfer funds from your bank account and even have the ability to set up automatic contributions. However if you prefer to mail a paper check, that is an option as well.
Once you’ve made your initial investment you can begin choosing the investments for the plan. Many people gravitate toward an age-based portfolio. What this means is that the plan starts with an aggressive mix of investments that are mostly stock, then as the child approaches college age it shifts to less risky investments.
Depending upon the plan you selected you might only have one age-based portfolio option or have options for aggressive, moderate, and conservative portfolios.
Best Options for Opening a 529 Savings Plan
Selecting the best 529 savings plan is a personal decision. Consider the following options, but also be sure to check out the plans in your state if they are not listed below.
Edvest – Wisconsin’s 529 Plan
The Edvest plan provides 18 age-based investment options that allow account custodians to create aggressive portfolios that can earn a higher return. It is an FDIC-backed product and uses funds from well-known asset managers. Additionally, Wisconsin residents can receive state tax deductions up to $3,380.
Best For: Aggressive portfolios
- Many age-based investment options
- Low fees
- High maximum contribution
- Modest tax deductions compared to other states
Contribution Limit: Edvest requires a minimum investment of $25. The maximum contribution is $516,000. Fees for this plan range from 0.14% to 0.41%.
Direct Plan – New York’s 529 College Savings Program
New York’s Direct Plan offers low-cost options that use Vanguard Funds, a leader in keeping low investment costs. Like Wisconsin’s plan, it also has a very high maximum contribution, one of the largest in the country. Residents of New York can see state tax deductions up to $10,000 for joint filers ($5,000 for single filers). This helps offset the state’s high taxes.
Best For: Vanguard funds
- Low fees
- High tax deductions
- High maximum contribution
- Limited investment options
Contribution Limit: New York’s 529 College Savings program has no minimum investment. The maximum contribution is $520,000. Fees for this plan range are 0.13%
Direct Plan CollegeAdvantage – Ohio’s 529 Plan
With as little as $25, you can open a 529 plan in Ohio (with CollegeAdvantage). The investment portfolios cater to all levels of risk, and the plan has a higher maximum contribution of $500,000. This is another FDIC-backed account and also uses Vanguard funds.
Best For: Low fees
- Low fees
- In-state tax deductions up to $4,000
- Higher fees for Advisor-sold plans
Contribution Limit: Ohio’s 529 plan requires a minimum investment of $25. The maximum contribution is $500,000. Fees for this plan range from 0.04% to 0.55%.
UNIQUE College Investing Plan – New Hampshire’s 529 Plan
With the highest maximum contribution of $542,000 per beneficiary, New Hampshire’s UNIQUE College Investing plan is great for account holders looking to maximize the plan. The state of New Hampshire does not collect state tax, so there are no state tax breaks with this plan.
Best For: Maximum contribution limit
- High contribution limit
- Low fees
- Limited investment options
Contribution Limit: New Hampshire’s 529 plan requires no minimum investment. The maximum contribution is $542,000. Fees for this plan range from 0.05% to 0.99%.
Bright Start Direct-Sold – Illinois College Savings Program
If you live in the state of Illinois, the state tax benefits of the Bright Start Direct-Sold college savings program can’t be beat. With an annual tax deduction of $20,000 couples can see maximum tax benefits with this plan.
Best For: In-state tax deductions
- Low fee investment options
- Different risk level options
- In-state tax deductions up to $20,000
- Maximum contribution limit is lower than other states
Contribution Limit: Illinois 529 plan requires no minimum investment. The maximum contribution is $450,000. Fees for this plan range from 0.11% to 0.83%.
Investing in the Future with a 529 Plan Today
After you have reviewed all your 529 college savings options, it might be worthwhile to run your ideas by your financial advisor. They can provide an in depth look at the various options and help ensure that you are on the right track.
Additionally, they can work alongside your CPA to help you get the most tax benefit out of your desired college savings plan.