As student debt continues to dominate economic and budgeting discussions, many parents are seeking ways to minimize or even eliminate their child’s need for student loans. But how can you help your child achieve their educational goals without the burden of debt?
One of the best strategies is to start saving for college early. A 529 plan, as highlighted in our Beginner’s Guide to College Financial Planning, allows you to save money for education in a tax-advantaged account, helping you pay upfront rather than relying on loans that accumulate interest over time.
This article explores the ins and outs of college savings plans and what to watch out for as you plan your child’s educational future.
What Is a 529 Plan?
A 529 plan is a tax-advantaged savings plan designed specifically for education expenses. You don’t pay taxes on the money you contribute, and withdrawals for qualified education expenses—like tuition, fees, and room and board—are also tax-free. These accounts are typically set up for a child or grandchild, known as the “beneficiary.”
Formally called Qualified Tuition Programs, 529 plans get their name from the section of the Internal Revenue Code that outlines them. The two primary types of 529 plans offer different ways to make the most of your savings.
Types of 529 Plans
529 plans are administered by states, with two basic types to choose from:
1. College Savings Plans
These plans function like investment accounts, allowing your money to grow tax-free through market performance, typically in mutual funds. Most college savings plans are age-based, meaning the investments become more conservative as the beneficiary approaches college age.
College savings plans can be used for a wide range of educational expenses, including tuition, fees, and room and board, and can apply to nearly any college or university—even some elementary and high schools in certain states.
2. Prepaid Tuition Plans
Offered by a few states and institutions, prepaid plans let you lock in today’s tuition rates for the future. When your child is ready for college, the account pays out at the rate locked in when you started the plan.
However, prepaid plans come with more limitations: they typically can’t be used for room and board, have residency requirements, and are often restricted to specific schools.
Pros and Cons of 529 Plans
As with any financial investment, it’s important to weigh the benefits and drawbacks of a 529 plan.
Pros
- Many state-offered 529 plans come with added benefits, such as tax breaks or matching contributions.
- There are no mandatory withdrawal requirements, and unused funds can be rolled over to another beneficiary, like a sibling or even a future grandchild.
Cons
- Investment options may be limited, and some plans may lack flexibility in how funds can be used.
- Funds used for non-qualified expenses incur a 10% penalty and taxes.
- Fees and commissions can reduce the overall growth of your investment, so it’s important to review all associated costs.
- Having a 529 plan may impact your child’s eligibility for need-based financial aid.
We make it easy to find an advisor near you to get started on planning for a bright, debt-free future for your child or grandchild.
