Money Health

Should You Start a 529 Plan?

529 Plans
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Whether you are preparing for a new baby or already have children, the thought of sending your little one(s) to college may already be in the back of your mind. Since every parent wants to send their kids to the best school possible, saving for college has become even more important thanks to the ever-growing cost of tuition.

According to the National Center for Education Statistics, between 2008 and 2017, the average cost at a four-year public institution increased by 12% for first-time undergraduates. During this same time, private nonprofit institutions saw a 17% increase in tuition and fees.

To lessen the blow of rising tuition, some parents may be considering a 529 plan to save for college. If you are wondering what a 529 plan is and how you might use one to help you put your kids through college, read on to better understand the basics of saving for college with a 529 savings plan.

What is a 529 plan?

A 529 college savings plan is a type of investment account you can use to pay for qualified education expenses. These plans are usually state sponsored, and can offer some tax benefits. Anyone can start a 529 plan, including parents, grandparents, friends or other relatives. Whoever opens the account may gain tax benefits if their state offers a state tax deduction for 529 contributions.

Contributions to a 529 plan are made with post-tax dollars. In other words, you pay state and federal tax on the money you put into the account. In some cases, your employer may offer a matching program into a 529 plan and those contributions are also taxed up front. Since your contributions to a 529 plan are with post-tax dollars, the savings in the account grows tax-deferred. You may then withdraw the funds tax-free as long as the money is used for qualified education expenses.

Qualified education expenses

According to the IRS, a qualified education expense is any expense that is required for enrollment or attendance at an eligible institution. Qualified education expenses include:

  • Tuition and fees
  • Room and board
  • Student activity fees
  • Books and supplies
  • Equipment such as laptops, printers, or software

Room and board expenses can be covered by money from a 529 plan if the student’s housing is owned or operated by the school. If a student chooses to live off campus, you can use up to the allowance for room and board as determined by the school. For example, if the school determines $9,500 is the cost of room and board for the year, you can use up to $9,500 in a 592 plan towards off-campus housing.

Two types of 529 plans

There are two types of 529 plans, including prepaid tuition plans and education savings plans. There are advantages, drawbacks, and requirements for each, so you’ll want to make sure you understand the differences.

Prepaid tuition plans – This type of 529 plan allows the account owner to purchase credits or units at participating universities or colleges in advance. The advantage is that you will lock in today’s tuition rates even though the beneficiary won’t attend college until years later. One drawback is you can’t use the plan to pay for future room and board. Another limitation: If your beneficiary doesn’t attend a participating college or university, then the prepaid tuition plan may only pay a small return on your original investment.

Education savings plans – This plan allows the account owner to contribute to an investment account to save for the beneficiary’s qualified education expenses, including post-secondary and K-12 expenses. The investment grows tax-deferred over time and withdrawals are tax-free when used for the qualified expenses. The drawback of this version is that there is some risk as you could lose money in the account, depending on market fluctuations. Keep in mind if you use the plan for K-12 expenses, you’ll have less time to contribute even if you start very early in the child’s life.

Which states offer a tax benefit for 529 plan contributions?

Not all states offer a tax benefit for in-state contributors, but if you live in a state that doesn’t offer a tax deduction, you can still open a 529 plan with an investment company of your choice*. If your state offers a tax benefit, it’s probably worth signing up for your state’s plan. Here is a comprehensive list:

State Offers tax benefit for in-state contributors?
Alabama Yes
Alaska No
Arizona Yes, and also to any 529 plan*
Arkansas Yes
California No
Colorado Yes
Connecticut Yes
Delaware No
District of Columbia Yes
Florida No
Georgia Yes
Hawaii No
Idaho Yes
Illinois Yes
Indiana Yes
Iowa Yes
Kansas Yes, and also to any 529 plan*
Kentucky No
Louisiana Yes
Maine No
Maryland Yes
Massachusetts Yes
Michigan Yes
Minnesota Yes
Mississippi Yes
Missouri Yes, and also to any 529 plan*
Montana Yes, and also to any 529 plan*
Nebraska Yes
Nevada No
New Hampshire No
New Jersey No
New Mexico Yes
New York Yes
North Carolina No
North Dakota Yes
Ohio Yes
Oklahoma Yes
Oregon Yes
Pennsylvania Yes, and also to any 529 plan*
Rhode Island Yes
South Carolina Yes
South Dakota No
Tennessee No
Texas No
Utah Yes
Vermont Yes
Virginia Yes
Washington No
West Virginia Yes
Wisconsin Yes
Wyoming No state plan

Investment companies that offer 529 plans

There are plenty of investment companies that offer 529 plans to help you save for college. The benefit of using an investment company is that you have more flexibility in what investment funds you want to invest in with your 529 money. For example, if your state plan uses TIAA funds but you prefer Vanguard funds, you can open your 529 plan with Vanguard directly.

A few investment companies that offer 529 plans include:

  • Vanguard
  • TD Ameritrade
  • Fidelity
  • USAA
  • Merrill

Who can be a beneficiary

Google “what is a 529 plan”, and you’ll learn that you can designate a beneficiary of your choice: a child, grandchild, family member, or a friend. You can even open a 529 plan for yourself and use the money for your own education expenses. If you want to save for a child in the future, you can open the 529 plan in your name and then transfer the account once your baby arrives.

If you decide to change the beneficiary, you can only transfer the funds to a member of the beneficiary’s family. The definition of “member of the family” is broad and includes:

  • Son, daughter, step-child, foster child, adopted child, or a descendant of any of them
  • Brother, sister, step-brother, or step-sister
  • Father or mother or ancestor of either
  • Step-father or step-mother
  • Son or daughter of a brother or sister
  • Brother or sister of father or mother
  • Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
  • The spouse of the beneficiary or any individual listed above
  • First cousin

Can I use a 529 plan to pay for elementary and secondary education?

If you are wondering if the cost of attending college is worth it, you should know that in 2017, 529 plans were expanded to cover K-12 education expenses, which we touched on earlier in this post. If you decide not to save for a college education, a 529 plan makes it possible for parents to cover education expenses for an earlier stage of education.

You can use up to $10,000 per student per year towards K-12 tuition and fees at a qualifying public, private or religious school. Books, supplies, computers and internet access are not qualifying expenses for K-12 schools.

Saving for college starts with a money management plan

If you want to start a 529 plan but have other responsibilities like debt management and covering your bills, the Freedom Debt Relief debt management guide can walk you through your options and help you formulate a plan. Get started by downloading the How to Manage Debt guide here.

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Justine Nelson is the founder of Debt Free Millennials, an online community to help millennials eliminate debt and live a debt free lifestyle. As a freelance writer and YouTuber, Justine enjoys creating upbeat and educational personal finance content. This Midwest millennial paid off $35k in student loan debt and now resides in San Diego with her husband.