Using a 529 Plan to Save for College

One way to help manage the expenses associated with raising children is to start saving for college early. A 529 college plan is one way to accumulate a large amount of savings over time to help defray the cost of qualified education expenses. These costs include tuition for both full- and part-time students, and room and board if the student is attending college at least half-time.

529 plans earn more than standard savings accounts because they’re tied to investment portfolios (similar to defined benefit pension plans). You can use 529 plans as prepaid tuition plans or as college savings plans. If you use the plan as a prepaid tuition plan, you can lock in an interest rate in exchange for paying a portion of tuition in advance. (The terms for this strategy vary greatly.)

Though a recent survey revealed many Americans don’t know what a 529 plan is, the number of accounts opened and the average size of accounts have increased, according to the College Savings Plan Network.

Your annual tax-free contribution limits are the same as the gift tax limit, which is $15,000 for 2018 (up to $30,000 for a married couple making a split-gift election). You can contribute more, but your contributions above those thresholds will incur the gift tax.

These accounts generally have one owner, but contributors do not have to be the owner.

Changes to 529 Plans from the Tax Cuts and Jobs Act

As a part of the Tax Cuts and Jobs Act (TCJA), you can now complete annual $15,000 rollovers from a 529 account to an ABLE (achieving a better life experience) account. ABLE accounts are tax-advantaged savings vehicles that an eligible individual with special needs can use to pay for disability expenses. The beneficiary of the 529 ABLE must be either the beneficiary of the original 529 or a family member of that beneficiary. Since the ability to roll over funds from a 529 plan into an ABLE plan is new, states are still working out many of the details. If you are interested, contact your respective state to learn what options are available.

TCJA has also eased restrictions for funding 529 plans. For example, you can now use some of the funds to pay for pre-college education. You can now withdraw $10,000 from a 529 account to pay tuition for primary and secondary education. Some states are an exception to this rule and will still charge penalties for any expenses not related to a college education. 

Benefits of 529 Plans

Virtually every state offers a 529 plan directly to taxpayers. You’re not limited to your state’s plan, though the state income tax benefits are usually better if you do work with the plan for the state you reside in. Financial advisors and brokers can sell you a 529 plan, but they will charge a fee for their services. If you decide to open a 529 account through your financial planner or broker, scrutinize the portfolio within the plan because they can vary a great deal. (For related reading, see: 529 Risks to Take (or Not).)

An additional benefit of using a 529 plan is some of them are indexed to current tuition costs. You can pay for one semester, a school year or up to all four years of college in today’s dollars. (To qualify, your child must go to a school in your state; if your child goes to an out-of-state college, the future credit will equal the tuition cost in your home state).

Comparing Plans

Comparing 529 plans side-by-side is an excellent way to start the critical college savings process. Recently, Saving for College, a privately-run site that provides research on college financial planning instruments like 529 plans and financial aid, gave its first-quarter report, ranking the top 529 plan providers. The website analyzes 529 plans quarterly on their one-, three-, five- and 10-year performance using its own methodology. Portfolios from all direct-sold and advisor-sold 529 plans are assigned to a specific asset allocation category depending on percentage of equity, fixed-income and short-term. Within each category, portfolios are compared and ranked based on published investment returns. In the most recent 2018 ranks, the plans in California, Alaska, New York and Nevada ranked highest.

Paying for your child's education can be quite a financial undertaking, but starting to save early with the right 529 plan can help.

(For more from this author, see: What's Causing the Death of the Retail Store?)