According to College Board, the average cost of a 4-year Bachelor’s degree in 2018 was $87,613(1). And while many students can qualify for Pell Grants and government subsidized loans, this enormous financial burden can still be too large for students to bear alone(2). For parents looking to ensure their children receive a high quality education, a 529 plan may offer an excellent way to begin saving now.
What is a 529 plan?
A 529 plan is a savings plan designed to encourage saving for the expenses of future college costs. A 529 plan also has tax advantages as well. Legally known as “qualified tuition plans,” 529 plans are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. 529 plans fall into two categories: prepaid tuition plans and college savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. Additionally, some private colleges and universities sponsor a prepaid tuition plan.
According to the rules governing 529 plans, each beneficiary can have only one account. This implies that a large percentage of students will use funds from a 529 account to finance their college education. Why are 529 plans (named after Section 529 of the federal tax code) so popular? Here are some of the principal benefits that they offer:
Save for Your Child’s Education and Get Tax Benefits at the Same Time
A 529 plan is exempt from federal taxes. Additionally, many states also provide tax exemptions for these accounts. As a result, it is possible to save a significant amount of money by opting for a 529 account. Of course, there are several places where there is no income tax at the state level. If you live in Texas, Florida, Washington, or one of several other states there is no additional tax benefit for maintaining a 529 account. But you will still be eligible for federal income tax benefits.
However, bear in mind that you need to comply with certain rules to get these benefits. For example, if you use the money for expenses that are unrelated to the beneficiary’s (presumably your child’s) college expenses, you will need to pay back the tax exemptions that you received. You may also be liable to pay a penalty.
Flexibility to Use the Money That You Save
How can you use the money that you accumulate in a 529 account? Permitted expenses include:
- The amount payable for tuition to the college.
- Room and board.
- Computers and related equipment.
The amount that you spend must be directly related to the beneficiary’s college education. What if your child decides not to go to college? Fortunately, this does not mean that you will have to forgo your tax benefits. You have the flexibility to change the beneficiary to one of the beneficiary’s relatives. The switchover may be made to the original beneficiary’s brother, sister, first cousin, aunt, or uncle. There are several other relatives who can receive the 529 funds without the account holder having to lose tax benefits.
A Wide Range of Investment Options
You can choose how your money will be invested. It is possible to opt for low-risk investments. But if you do this, it is likely that you will make low returns. If you start saving early, it is advisable to opt for investments that carry a higher degree of risk. This would increase the possibility of earning a higher return on the funds in your 529 account. The money that you put aside will typically be deployed in mutual funds. These carry varying degrees of risk. Funds that allocate a greater amount to stocks are preferable when the beneficiary is young. But as the child grows older and approaches the date of admission to college, it will be advisable to switch over to a more conservative portfolio. It is possible to opt for a 529 plan that automatically adjusts its asset allocation in this manner. However, if you don’t want to follow this approach, you can select the type of investment that you prefer.
Anyone Can Contribute/Exemption from Gift Tax
This is an important benefit of a 529 plan. All contributions do not need to come from the account holder. Other people can contribute too. It is also important to know that the sums that are paid into the 529 account are treated as gifts. An amount of $14,000 per beneficiary can be given as a gift every year without attracting gift tax. There is also an option to pay $70,000 in a single year without incurring federal gift tax. This amount will utilize the exemption limit for five years. It is a good idea to pay a lump sum into the account if you can afford it because your investment will earn a return for a greater number of years. Married couples can contribute as much as $140,000 in a single year under this rule.
You Get the Money Back if Your Child Receives a Scholarship
What happens if your child gets a scholarship and does not require the funds that have accumulated in the 529 account? You can simply withdraw this money and use it for whatever you like. However, you would have to pay income tax on the sum that you withdraw. But you would not need to pay any penalty. The sum that you can take out of your 529 account in this manner is limited to the scholarship amount.
529 Plans Are an Excellent Option
If you have young children and you would like them to attend college, should you open a 529 account? Most definitely, Yes. You will be able to save in a tax-efficient manner and the amount that you put aside will be available when you need it. Additionally, if your investment performs well, the sum that is available to you will be significantly greater than the amount that you have put into the account.
1. https://bigfuture.collegeboard.org/pay-for-college/college-costs/college-costs-faqs 2. https://www.eab.com/blogs/the-community-college-blog/2017/05/why-federal-financial-aid-isnt-enough-for-students