If you have had a child (and I’m guessing you do to be reading anything on this site) you know that there are many daunting feelings that come with parenthood. However, one that seems more and more daunting as the years go by is the rising cost of a college education.
My husband and I decided before we had kids that we would like to pay for their college education. We knew that meant that:
- We couldn’t have a gaggle of children or we’d go broke.
- We would have to figure out how to save in a way that would be impactful by the time our kids attend college.
Our daughter was born in 2012, which means she will be attending college in 2030 when the annual, average cost is expect to be around $45,000 per year according to the United States Department of Education. She and our son will both be in school at the same time for at least one year too.
We have been looking into better options for saving versus just the run of the mill savings account and recently heard about 529 Plans. I wanted to share some of my findings with you on what I discovered about 529 Plans as I imagine you are also panicked about either paying for college or sending your child off to school with loans that will amount to around $200,000 by the time they graduate. So here are the basic facts about 529 Plans that you need to know.
What is a 529 Plan?
A 529 Plan is a college savings plan operated by states or by educational institutions in an effort to help families safe for the cost of college. Its name comes from the 529 section of the Internal Revenue Code, which created the plans in 1996 to help families with the mounting cost of tuition.
More than 30 states provide tax deductions or tax credits for contributions to a 529 Plan. However, contributions do not reduce your taxable income.
There are two main types of plans – a Savings Plan and a Pre-Paid Tuition Plan.
What’s the difference between the two types of plans?
Savings Plans are only offered by states and are similar to IRAs in that they are a way to invest money in education long-term. Plan holders can generally invest in a range of mutual funds, which will attempt to reduce risk exposure as the date of freshman year approaches. The amount that is available for eligible education expenses will be impacted by the rate of return on investments.
Prepaid Tuition Plans are offered by states and education institutions to allow the plan holder to prepay for one or more semesters at designated colleges and universities AT CURRENT PRICES for a fixed period of time or a fixed number of credits. This helps to shield people from the cost of inflation, which has been about 6.5% per year according to the USDE, and the program bears the risk of investments.
These plans will often have caps or residency requirements and are generally stricter about what expenses they will cover. Text books and room and board may not be included in what the plan will cover.
What do the plans cover?
The earnings of a 529 Plan can be used towards all qualifying educational expenses, which includes tuition, books and room and board. Unless you have a Pre-Paid Tuition Plan that limits these expenses to a select few.
Do you need to pay taxes on the money withdrawn?
A 529 Plan is an investment plan and is not subject to federal and (generally) state tax when earnings are used for qualified educational expenses for the beneficiaries. Meaning, when you withdraw the money to use for school you will not have to pay taxes on that withdrawal.
Withdrawals that are not used to pay for qualifying educational expenses are subject to taxes and a 10 percent fee unless there has been a death or disability.
How do you become eligible?
Everyone is eligible for a 529 Plan. There are no income limits, age limits or annual contribution limits. There are lifetime contribution limits that vary by plan.
How is the account managed?
The accounts are typically low maintenance. You can enroll through a website or by contacting your financial adviser. Most plans allow automatic payroll deductions or withdrawals from your bank account. Ongoing management is usually handled by an outside investment firm hired to act as program managers.