What is a 529 Plan?

What is a 529 Plan?What is a 529 Plan? Great question! A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

The two main types of 529 plans are prepaid tuition plans and college savings plans. Prepaid tuition plans allow you to purchase units or credits at participating colleges and universities for future tuition and fees at today’s prices. College savings plans resemble Roth IRAs in that funds grow tax-free and can be used tax-free for qualified expenses. With a college savings plan, you open an account with a sponsoring institution and invest in a portfolio of mutual funds or other  investment options.

What is the Main Benefit of a 529 Plan?

The main benefit of a 529 plan is that it offers tax-free growth and tax-free withdrawals for qualified education expenses. This can be a significant advantage over other types of savings vehicles such as savings bonds or Coverdell Education Savings Accounts, which only offer tax-free growth. Withdrawals from 529 plans are not subject to federal income tax and may also be exempt from state income tax in some states.

What are the Drawbacks of 529 Plans?

One drawback of a 529 plan is that the funds can only be used for qualified education expenses, such a tuition, fees, books, and room and board. If the money is used for non-qualified expenses, such as student loan repayment or rent, then the earnings portion of the withdrawal will be subject to income taxes and may be subject to a 10% penalty. Another drawback is that if the beneficiary decides not to go to college or attend a qualifying institution, then the account owner will incur taxes on the earnings and may have to pay a 10% penalty.

A major downside of a 529 plan is that it can impact your child’s ability to qualify for need-based financial aid. In some cases, a 529 plan can increase the Expected Family Contribution calculation. This means that the amount the government calculates your family will be able to contribute toward educational expenses is higher, and thus, your student will likely receive fewer federal grants, work-study opportunities, and subsidized loans.

529 plans are often expensive and require a large up-front investment. Some states require a $500 opening deposit, while others require $1,000. If you cannot afford to make such a large contribution, this college savings tool may not be the right one for you.

What happens to a 529 Plan if your child doesn’t go to college?

What is a 529 Plan?If your child doesn’t go to college, you can either withdraw the money and pay the taxes and penalties, or you can change the beneficiary on the account to another qualifying family member. If you decide to withdraw the money, you will have to pay income taxes on the earnings, as well as a 10% penalty. If you decide to change the beneficiary, there are no taxes or penalties incurred.

If your child realizes they do not wish to attend college while they are still young, you may be able to use 529 plan funds toward tuition at a private school, although there may be a small tax penalty (depending on the state you live in).

Why Should I Consider Saving for College in a 529 plan?

There are several reasons why you should consider saving for college in a 529 plan. First, as mentioned above, 529 plans offer tax-free growth and tax-free withdrawals for qualified education expenses. This can be a significant advantage over other types of savings vehicles, such as savings bonds or Coverdell Education Savings Accounts, which only offer tax-free growth.

Another reason to consider saving for college in a 529 plan is that it can help you save on your taxes. If you contribute to a 529 plan, you may be eligible for a state income tax deduction or credit. In addition, some states offer special incentives for contributions to 529 plans, such as matching grants or scholarships.

Finally, there are no income restrictions for contributors to 529 plans. This means that even if you are not the child’s parent or guardian, you can still contribute to a 529 plan on behalf of the child.

How to Open a 529 Plan

If you’re interested in exploring more about a 529 plan, want to get specifics on your financial situation, and learn how to best save for your child’s college education, Eden Accounting can help you. Make a consultation appointment today to learn your many options for saving for college, including the best 529 plans, life insurance, and more!