College is very, very expensive. According to Student Loan Hero, the average class of 2016 graduate will have $37,172 in student loan debt. With tuition costs rising about 5% a year, parents all over are looking for ways to participate in funding their children’s college expenses, lessening their need to rely on student loans.
529 plans are fantastic options.
Why use a 529? There are great tax incentives! Plan assets grow tax-deferred, and if used on a qualified educational expense, the distributions are tax-free. Even better, many states offer other great tax incentives to use their state-sponsored plan. These incentives come in the form of tax deductions or tax credits against your state income tax liability. You also have flexibility in choosing from a wide array of investments within 529 plans.
There are also many great benefits to 529s that aren’t as well known. If you own—or want to start—a 529, it’s important to learn them. (For related reading, see: Student Loan Debt: What Every Student Should Know.)
529s Are Flexible
529 plans offer great flexibility if you need to manage multiple accounts. You can change the beneficiaries on the accounts you own once a year. You can also transfer funds from one account to another. Have a child that gets a full-ride scholarship and doesn’t need his or her 529 funds? You can change the beneficiary on the account to a sibling or relative. If a graduating child has funds left over in his/her account, you can transfer the funds for the benefit of a younger child.
You Can Open a 529 for Yourself
Want to go back to school to get your MBA? Maybe you want to go to law school or take night classes to finish your degree. Open a 529 for yourself. If you don’t have kids yet but you want to get a leg up on college savings, you can open an account and name yourself as beneficiary until you have kids. Then, you simply change the beneficiary to your child. Did I mention 529s are flexible?
One pushback I often hear from clients is, “What if my child gets a big scholarship? Won’t I have to pay a 10% penalty on top of income taxes?” Not necessarily. You will have to pay income taxes on the earnings because they weren’t used for a qualified educational expense, but any earnings you take out to offset the scholarship are not subject to the 10% penalty. There are other exceptions, including disability or if the beneficiary attends a military academy. Remember, the principal amount invested will not be taxed or penalized. (For related reading, see: New Parents: A Financial Planning Checklist.)
Minimal Impact on Financial Aid
The financial aid impact of assets in a 529 plan when determining your financial aid eligibility are favorable. 529 plan assets held in the parents' or a dependent child’s name only factor into the federal financial aid formula at a maximum rate of 5.64%. This is much more favorable than traditional savings or brokerage accounts, which can be factored in as much as 20%. This can be helpful when filling out the FAFSA to establish your expected family contribution (or EFC). The lower the EFC, the higher the financial aid eligibility.
Not Limited to Tuition
You can also use these plans to fund off-campus housing as long as your student is enrolled at least half-time and the expenses do not exceed the school’s room and board allowance in its published cost of attendance. The chances of it being more expensive than the school’s room and board allowance are slim as the cost of campus housing can be excruciating. Also, you can now use 529 plans to purchase computers. Consider contributing that money to a 529 plan first if your state offers a tax-incentive to contribute to its plan. Tax deductions and credits are a terrible thing to waste!
529 plans are a great option for funding college expenses. College costs sure don’t look like they will be getting any cheaper so it is important to start saving for college as early as possible. Before opening a 529 plan, make sure you look into your state’s plan to see if there is an incentive to use the in-state option. (For related reading, see: Saving for College: Top 4 Lessons I Learned.)