529 Plans: Your Most Pressing Questions Answered

As fall settles in—the days get shorter, the heat starts to let up—we're deep in school mode. It can be a busy and stressful time for families, especially if a member of your household is approaching college age. But even if your student is in elementary school or younger, the best time to think about the future of their education is now.

From a financial perspective, it can be unnerving to see the high cost of college education and think about your children or grandchildren applying for loans that can result in overwhelming debt, which might take decades to pay off. If we intend to assist with the cost of their education, we cannot put off planning until the last minute. That’s easy enough to say, but it’s harder to act on. While there are multiple means of attaining the same goal, one of the most efficient and flexible methods to save for the cost of higher education is through a 529 savings plan.

As a certified financial planner, I’d like to highlight some of the most frequently asked questions about using 529 plans to save for the anticipated costs of post-secondary schooling. (For more, see: 5 Secrets You Didn't Know About a 529 Plan.)

What Is a 529 Plan?

The 529 plan is a college savings vehicle designed with tax benefits. A 529 can be set up for any person intending to participate in post-secondary education (including a university, community college, trade school, etc.). The account is owned by an individual, usually (but not limited to) a parent or grandparent, and has a designated student for whom the assets are expected to benefit.

529 plans have a number of benefits, the most significant of which involve tax efficiency. The two most critical tax benefits include:

  1. Tax-free growth of assets within the 529 account, including the appreciation of underlying investments as well as income generated.
  2. At the time of need, withdrawals used for qualified education expenses are free from federal taxation. See the next question for what the IRS deems to be qualified education expenses.

Another key benefit is that schools do not identify the 529 assets as being owned by the student when determining financial aid. With some alternative educational savings plans, this is not the case. (For related reading, see: 5 Financial Strategies to Last a Lifetime.)

What Are Qualified Higher Educational Expenses?

Money from a 529 can be withdrawn tax-free if used for qualified education expenses which include tuition and reasonable room and board. Funds may also qualify if used for books, calculators, software, and, as of recently, computer equipment and related technology services, including Internet service fees if used primarily for educational purposes.

If the intended beneficiary does not elect to participate in post-secondary studies, there are a couple of options available for the assets held within 529 plans. First of all, you can change the student for which the 529 assets are meant to benefit. This means simply redirecting the money to a different family member or generation. You can also withdraw the assets for any other purpose and close the 529. In doing so, be advised the assets from the plan will be subject to taxes and incur a 10% penalty.

Uncomfortable Managing the Investments Yourself?

Some 529 plans offer online tools or basic assistance with investment decisions, but it’s ultimately up to the account owner to choose. Many funds offer age-based investment strategies which automates changes in investment allocation as the intended student gets older. And some financial advisors will provide guidance for 529 plans as part of their service. (For related reading, see: Student Loan Debt: What Every Borrower Should Know.)