The Benefits of Investing in a 529 Plan for Your Child’s education

What is a 529 Plan?

A 529 plan is a type of investment account that offers tax benefits to encourage saving for education costs. 529 plans are usually sponsored by states, state agencies, or educational institutions.

The Benefits of Investing in a 529 Plan for Your Child’s education

When you contribute money to a 529 college savings plan, your money grows tax-deferred. That means you don’t pay taxes on any gains each year. Instead, no taxes are due on withdrawals as long as you use the money to pay for qualified education expenses of the named beneficiary, such as your child or grandchild. This feature makes 529 plans one of the best ways to save and invest for your child’s future college costs.

Why Open a 529 Plan?

There are many great reasons to open and contribute to a 529 college savings plan. Here are some of the key benefits:

Tax-Deferred Growth

Like I mentioned earlier, investments in a 529 plan grow tax-deferred each year. When you eventually withdraw funds to pay for college, you won’t pay federal taxes and usually not state taxes on the gains as long as the money is used for qualified education expenses. This significant tax advantage helps your money grow faster over the years you save.

Tax-Free Withdrawals

Another fantastic benefit is that 529 withdrawals to cover qualified higher education expenses are tax-free at the federal level and usually at the state level too. The definition of “qualified expenses” here includes a lot of college spending—things like tuition and fees, room and board, textbooks, computers and other equipment.

Flexibility

529 plans offer more flexibility than you may think. You can open a plan in any state’s program regardless of where you live and assets aren’t tied to just one school or education path. Funds can be used at any accredited U.S. college, university, or technical/vocational school. Or they can even cover K-12 tuition expenses up to $10,000 per year.

High Contribution Limits

Compared to other education savings vehicles, 529 plans have very high contribution limits, usually over $300,000 in most states. Such high limits make it easier for many grandparents, parents, relatives to contribute and accelerate college savings.

Financial Aid Benefits

An important thing to note is that 529 plan assets have less impact on financial aid calculations than ordinary savings accounts. They are treated as parental assets which are assessed at a maximum rate of 5.64%, rather than the higher 20% rate applied to student assets like UTMA/UGMA custodial accounts. This makes contributing to a 529 plan preferable over other options.

Estate Planning Benefits

A cool benefit of 529 plans not known by everyone is their use for estate planning goals in addition to college savings. For example, individuals have the option to contribute 5 years’ worth of the $15,000 gift tax exclusion into a 529 account in one year ($75,000 for individual, $150,000 per married couple). This allows them to easily reduce the size of their future taxable estate.

Choosing a 529 Plan Provider

Now that you know why opening a 529 college savings plan is smart, here are some tips on how to choose the right plan for your needs:

Your State’s Plan

The best overall option is usually enrolling in your own state’s 529 plan because out-of-state plans may charge extra fees or offer fewer state tax breaks. 34 states provide a state tax deduction up to $10,000 for single filers contributing to their own state’s 529 plan. So make sure to research what perks your state offers.

Investment Options

Next, you’ll want to review the investment portfolios offered to have appropriate options for your preferred investment timeframe and risk tolerance. Age-based, risk-based and individual portfolios are common choices. And low-cost index options are ideal.

Performance and Fees

Carefully compare historical performance, ratings from sources like Morningstar and fees charged across potential plans. Higher investment returns mean more college money over 18+ years, while lower fees preserve more of your contributions. Reputable brokerages like Fidelity and Vanguard have highly competitive options.

Customer Service

Don’t forget to evaluate customer service offerings too including online access, advisor availability for guidance, plan details/statements sent by mail or email, etc. Reputable brands typically have solid customer support through phone, email or online chat.

Opening Your 529 Account

Opening a 529 plan is easy and often takes 15-30 minutes either online or by submitting a standard application form. You’ll need to provide some personal information like:

• Name and contact info
• Social Security Number
• Birthdate
• Beneficiary’s information
• Initial contribution method/details

After your new account is opened, you’ll receive confirmation plus information to create online login credentials for convenient ongoing access. Over time, you can change the beneficiary, update your contact info, adjust investment selections, check quarterly statements showing balances and activity, request withdrawals and more.

Contributing to Your 529 Over Time

With your shiny new 529 account setup, it’s time to start contributing! Consistently putting away money in your 529 plan is the key to accumulate enough funds to make a difference down the road. Here are tips to start strong:

• Contribute Often – Set up automatic recurring contributions from your bank account or paycheck to effortlessly build savings each month or quarter.
• Seed Money – Make an initial lump sum contribution to kickstart your 529 plan if possible from savings, tax refunds, gifts or inheritance.
• Custodial Fund Transfers – Consider moving assets from existing custodial savings accounts into the new 529 account for your child to benefit from better tax treatment and investment options.
• UGMA/UTMA – You can liquidate assets in a child’s custodial brokerage account tax-free if the money is deposited within 60 days into a 529 plan for the same beneficiary.
• Credit Card Rewards – Some 529 plans let you turn credit card rewards into college savings deposits for zero fees. An easy way to passively grow your funds.
• Gifting – Friends and family can directly contribute to a child’s 529 account through gifting for holidays, birthdays, other occasions up to $15k annually per person.

As you continue investing in your 529 plan, watch your hard-earned savings multiply thanks to the power of tax-advantaged compound growth over a decade or more.

Using 529 Funds Tax-Free for College

After years of disciplined saving and growth, the best part of having a 529 plan comes—using the money for college expenses without owing taxes!

To receive federal tax-free treatment on withdrawals, the funds must go towards “qualified education expenses” as defined by the IRS— things like:

• Tuition, Fees, Room & Board
• Textbooks, Supplies & Equipment
• Computers, Internet Access
• Special Needs Services

The actual withdrawal process is convenient too. Simply complete a withdrawal request online or by paper form indicating how much you need, where to send the money and if the distribution should come from contributions vs. gains.

Within 1-2 weeks, the funds can be sent directly to the college to pay current tuition/room and board bills online or a check can be mailed to your home address. Either way, no federal taxes or penalties as long as the money goes towards qualified higher education costs!

What If Plans Aren’t Used for College?

While the goal is to use 529 accounts for anticipated college expenses, life sometimes has other plans. If your child receives a scholarship, attends a tuition-free military academy, or doesn’t end up needing the money saved after all—you generally have a few good options:

• Change the Beneficiary – Transfer leftover 529 plan assets to another eligible family member like a sibling, cousin or future grandkids for their education and keep the tax advantages intact.
• Refund the Money – Cash out the 529 plan entirely and just pay back taxes and a 10% penalty on earned investment gains to close the account. You can then redirect the money elsewhere.
• Taxable Withdrawal Exceptions – If your child withdraws money from the 529 plan for non-college purposes, they would owe taxes on the gains plus a 10% penalty. But exceptions to the penalty apply in certain cases like death, disability, receiving a scholarship.

So while investing in a 529 college savings plan locks up money intended for education, there tend to be reasonable options if life circumstances change down the road.

Conclusion

I hope this guide gives you a helpful understanding of 529 plans – what they are, why contribute, how to choose one, opening and funding accounts over time. They can provide tremendous tax incentives that boost college savings significantly compared to using regular bank accounts.

With strategic saving, investment growth, and careful use for school bills, a 529 plan puts time and Uncle Sam firmly on your side. Before your child even applies to college, take the time now to start a tax-smart 529 fund so those looming tuition payments become far less intimidating down the road. Every dollar saved today can amount to three to four dollars or more by the time they walk across that graduation stage.