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Saving for Education: A Guide to 529 Plans

Saving for Education: A Guide to 529 Plans

Education can pave the way to a brighter future—but covering the costs is becoming an increasingly tall order.

The average student borrower takes 20 years to pay off their debt, which often translates to delaying other milestones, such as purchasing a home or starting a family. At the same time, the cost of in-state tuition at public colleges, typically the most affordable university education available to students, rose by 158% over the past 20 years.

With costs rising, federal loan programs fail to provide enough aid to all students. As a result, the share of private loans—which often carry higher interest rates and fewer borrower protections—in the overall student loan debt distribution doubled from the 2012-13 academic year to the 2022-23 academic year.

Fortunately, however, there is a highly effective tool available to prepare for future education expenses: a 529 savings plan. In this article, we’ll discuss how 529 plans work, their advantages, and just how effective they can be.

What Is a 529 Plan?

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. Broadly speaking, there are two types of 529 plans: prepaid tuition plans and education savings plans.

Prepaid Tuition Plans

Prepaid tuition plans allow savers to purchase courses and credits at today’s tuition rates at eligible colleges or universities, helping them manage future tuition costs. However, savers generally cannot use prepaid tuition plans to pay for other educational expenses, such as room and board.

Education Savings Plans

These plans allow savers to open an investment account to save for future qualified higher education expenses, including tuition, mandatory fees, and room and board. Funds from these plans can be used at many universities, community colleges, trade schools, and even some non-US schools.

Although created by federal legislation, 529 plans are administered by the 50 states and the District of Columbia. Notably, only nine states currently offer prepaid tuition plans, so most 529 plans are education savings plans.

How Does a 529 Education Savings Plan Work?

Understanding how a 529 education savings plan works can help you maximize its benefits. It is easy to save in a 529 plan, and the funds in the account grow tax-free. While contributions to 529s are not deductible for federal income taxes, many states offer tax deductions or tax credits for contributions to the state's 529 plan.

The plan is set up on behalf of a beneficiary—the person designated to use the funds for educational expenses. Commonly, parents set up 529s for their children. In this case, the child would be considered the beneficiary of the account. However, you may also be the beneficiary if you set the account up for yourself.

After making contributions, savers can construct an investment portfolio across different asset classes and vehicles, including mutual funds, exchange-traded funds, or target date funds. Within the 529 account, these investments grow tax-free and can be withdrawn tax-free to pay for qualified expenses.

Importantly, while there are no annual contribution limits for 529 plans, contributions made to them are considered “gifts” for tax purposes. Also, while all 529 plans are sponsored by state governments, most states do not have a residency requirement for the saver, meaning you generally can open an account in a state other than your own.

Gifting Education Through 529 Contributions

Growing in popularity among 529 savings accounts is the concept of gifting—where friends, family, and other loved ones can make digital contributions directly to an account. For holidays, birthdays, and other occasions (or no occasion at all!), individuals can make a contribution to an account that will support the beneficiary’s future educational expenses. Certain states may also provide those who contribute through gifting with a state income tax credit.

Gifting is permitted in many 529 state programs. For programs that allow gifting, savers can set up a gifting page attached to their account that allows them to share with loved ones who can contribute.

What Can You Spend 529 Plan Funds On?

With a prepaid tuition plan, you are mostly limited to spending funds on courses and credits. However, with an education savings plan—the majority of 529 plans—there is significantly more flexibility in how you spend your funds. Some of the expenses you can cover include:

  • Room and board, including off-campus if the expense is within the school’s published cost of attendance
  • Fees, books, supplies, and equipment
  • Computers, software, the cost of internet access, and other devices
  • Expenses related to students with special needs
  • Student loan repayment
  • …and much more!

There is also flexibility in the types of education that are allowed—529s are not strictly limited to a traditional 4-year college. Funds from education savings plans may also be used at most:

  • Community colleges
  • Accredited international schools
  • K-12s
  • Trade schools
  • Apprenticeships

529 education savings plans also provide versatility in the way funds can be transferred between qualified individuals or accounts.

  • Repayment of Student Loans: Qualified distributions can include payments made towards the principal and interest on existing student loans for both the beneficiary and their siblings. These payments are subject to annual limits.
  • Changing the Beneficiary: The account holder can change the beneficiary to another family member at any time. This includes immediate family, such as siblings, and extended family members, like grandchildren, nieces, nephews, and cousins.
  • Saving for Future Generations: If your child chooses not to pursue higher education or if there are remaining funds after their educational expenses are met, you can continue to invest in the 529 plan. These funds can be reserved for future educational expenses of grandchildren or other family members.
  • Transferring to an IRA: Are there leftover or unused funds in your 529 account? These remaining 529 funds may be rolled over into a Roth IRA without penalty. Certain rules and limitations may apply.

The flexibility offered by 529 education savings plans enables parents and other loved ones to help future generations of students pursue their educational aspirations.

Fees Associated With 529 Education Savings Plans

Fees and expenses can vary depending on the type of plan, whether it is sold directly or by a broker, whether it's actively or passively managed, and the underlying investments. Some of the fees that may be applicable to education savings plans include:

  • Enrollment or Application Fees
  • Annual Account Maintenance Fees
  • Program Management Fees
  • Asset Management Fees

Some of these fees are collected by the state facilitating the plan, and some are collected by the plan manager. When selecting a plan, it is important to understand the associated fees and how they may impact your investments.

Tips for Saving on 529 Plan Fees

There are a number of ways to minimize your plan fees, depending on the investments available to you and the structure of your plan. They include:

  • Participating in an automatic contribution plan
  • Maintaining a large account balance to reduce administrative fees
  • Participating in a state-facilitated plan in your state of residence

Conclusion: Is a 529 Plan Right For You?

A 529 plan is a powerful tool for parents, grandparents, or anyone else to help a loved one pay for the cost of higher education. When deciding to open a 529 plan, savers should consider their financial situation, know the cost trends within higher education, and have an open conversation with their loved ones about their family’s goals.

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