How to Open a 529 plan and Save for Future Educational Expenses

Home » Save » How to Open a 529 plan and Save for Future Educational Expenses
529 college planning - image shows a stack of money in front of a college building
College Spending DALL-E

According to data from the College Board for the 2022-2023 academic year, the average annual tuition and fees for public four-year in-state colleges was $10,940, while the average for public four-year out-of-state colleges was $28,240. The average annual tuition and fees for private nonprofit four-year colleges was $39,400.

It is important to note that these figures do not include additional costs such as room and board, textbooks, and other living expenses, which can add several thousand dollars to the overall cost.

With education costs continuing to rise, how do you pay for college? If you have multiple children, how do you pay for all of their education?

The earlier you start, the better off you are.

College education is becoming increasingly expensive, and parents and students are looking for ways to manage the cost. One popular option for saving for college is a 529 plan. In this blog post, we’ll explore what a 529 plan is, how it works, and the benefits of using one to save for college.

What is a 529 plan?

A 529 plan is a tax-advantaged savings plan designed to help families save for future education expenses. These plans are named after Section 529 of the Internal Revenue Code, which provides for tax-exempt status for qualified tuition plans. There are two types of 529 plans: prepaid tuition plans and college savings plans.

Prepaid tuition plans allow you to pay for future college expenses at today’s prices. This type of plan is typically offered by state governments and is limited to the public colleges and universities within that state.

College savings plans allow you to invest money in a tax-advantaged account to be used for future college expenses. These plans are offered by states and some private financial institutions, and the funds can be used at any eligible institution, such as a college, university, or vocational school.

How Does a 529 Plan Work?

When you contribute to a 529 plan, the funds are invested in mutual funds or other types of investment accounts. The earnings on the investments grow tax-free, and withdrawals are also tax-free as long as they are used for qualified education expenses.

Qualified education expenses include tuition, fees, books, supplies, and room and board for students attending an eligible institution. Additionally, many states offer state tax deductions for contributions to a 529 plan.

Benefits of a 529 Plan

College Library / Pexels

There are several benefits to using a 529 plan to save for college:

Tax benefits: One of the biggest advantages of a 529 plan is the tax benefits. Earnings in a 529 plan grow tax-free, and withdrawals are also tax-free as long as they are used for qualified education expenses. Additionally, many states offer state tax deductions for contributions to a 529 plan.

Investment options: College savings plans typically offer a range of investment options, including mutual funds, exchange-traded funds (ETFs), and age-based portfolios that automatically adjust the investment mix based on the age of the beneficiary.

Flexibility: 529 plans offer flexibility in terms of who can be the beneficiary, who can contribute, and how the funds can be used. One can change the beneficiary to another family member, and unused funds can be transferred to another family member or used for graduate school.

Consider the following as well:

Contribution limits: There are no federal limits on contributions to a 529 plan, but individual states may impose their own limits. Additionally, contributions may be subject to gift tax rules if they exceed the annual gift tax exclusion amount.

Financial aid impact: While 529 plans can help individuals save for education expenses, they may also impact a student’s eligibility for financial aid. The value of the 529 plan is considered when calculating a student’s financial need, which may reduce the amount of aid the student is eligible to receive. Also,withdrawals from a 529 plan can impact a student’s eligibility for need-based financial aid. However, the impact is typically less than if the funds were held in the student’s name.

Limited investment options: 529 plans typically offer a limited selection of investment options, which may not be suitable for everyone. This can limit an investor’s ability to tailor their investment strategy to their individual needs and risk tolerance.

Fees and expenses: Like any investment account, 529 plans may have fees and expenses associated with them, such as administrative fees and investment management fees. These fees can reduce the overall return on investment and erode the potential benefits of the tax-advantaged status of the account.

Potential loss of control over funds: Once funds are contributed to a 529 plan, the account owner has limited control over how funds are invested and used. Depending on the specific plan, the account owner may not be able to change the investment strategy or withdraw the funds for any reason other than qualified education expenses.

It is important for individuals to carefully consider the potential benefits and drawbacks of a 529 plan before investing. Consulting with a financial advisor or tax professional can help individuals make an informed decision based on their individual needs and circumstances.

Tips for Using a 529 Plan

Here are some tips for using a 529 plan to save for college:

Start early: The earlier you start saving for college, the more time your money has to grow.

Consider your investment options: College savings plans typically offer a range of investment options. It’s important to consider your risk tolerance and investment goals when choosing your investments. Look for funds with low expense ratios. The lower the expense ratio on your funds, the more your money can grow.

Contribute regularly: Set up automatic contributions to your 529 plan to make sure you’re saving regularly.

Monitor your account: Keep track of the balance in your 529 plan and adjust your contributions or investments as needed.

How do you open a 529 plan?

Andrea Piacquadio / PEXELs

To open a 529 plan, you generally need to follow these steps:

Choose a 529 plan: There are many different 529 plans available, each with its own set of investment options, fees, and features. It is important to research different plans to find one that meets your needs and goals.

Determine the beneficiary: The beneficiary of the 529 plan is the person who will use the funds for education expenses. This can be the account owner themselves, their child, or another family member. You will need to provide the beneficiary’s name, social security number, and date of birth when opening the account.

Gather necessary information: To open a 529 plan, you will need to provide personal information such as your name, address, and social security number, as well as information about your bank account or credit card to fund the account.

Complete the application: You can usually open a 529 plan online or by filling out a paper application. The application will ask for the information listed above, as well as other details such as your investment options and contribution amount.

Fund the account: Once the application is complete, you will need to fund the account with an initial contribution. This amount can vary depending on the plan, but is typically a minimum of $25 to $250.

Manage the account: Once the account is open and funded, you can manage it by making contributions, changing investment options, and monitoring the account balance.

Ok, after opening the 529 plan, what is the next step?

Contribute to the plan and invest.

Choose an investment strategy: Once the account is open, you will need to choose an investment strategy that is appropriate for your goals and risk tolerance. Most 529 plans offer a variety of investment options, such as age-based portfolios, which automatically adjust the asset allocation based on the beneficiary’s age, or static portfolios, which offer a set allocation of stocks, bonds, and other investments.

Make contributions: Once you have chosen an investment strategy, you can make contributions to the account. You can make contributions through automatic transfers, payroll deduction, or by check.

Monitor and adjust the portfolio: It is important to monitor the portfolio on a regular basis and make adjustments as needed based on changes in the beneficiary’s needs, investment performance, and market conditions.

Withdrawing money from a 529 Plan

Anastasiya Gepp / Pexels

Let’s say that you contributed and invested over several years and your child needs money for educational expenses. What do you do?

Is the withdrawal is for a qualified education expense? 529 plan withdrawals are tax-free if they are used for qualified education expenses, which includes tuition, fees, books, and room and board for eligible educational institutions. If the withdrawal is not for a qualified expense, there may be taxes and penalties imposed.

Request a withdrawal: To withdraw funds from a 529 plan, you will need to contact the plan administrator and request a withdrawal. The process for requesting a withdrawal may vary depending on the specific plan, but can typically be done online or by submitting a paper form.

Provide necessary documentation: Depending on the reason for the withdrawal, you may need to provide documentation to support the withdrawal request. This can include receipts, invoices, or other proof of the qualified education expense.

Receive the funds: Once the withdrawal request is approved, the funds will be distributed to the designated recipient or institution. This process can take several days or weeks, depending on the plan and the method of distribution.

It is important to note that if the withdrawal is not for a qualified education expense, there may be taxes and penalties imposed. In addition, if the withdrawal is not for the benefit of the designated beneficiary, there may also be tax implications.

Summary

In conclusion, a 529 plan is a tax-advantaged savings plan that helps families save for future education expenses. These plans offer tax benefits, investment options, and flexibility, making them a popular choice for college saving. However, it’s important to research and compare different 529 plans to find the one that best works for your situation. This article highlighted what a 529 plan is, some pros and cons and information how to open a 529 plan and how to withdraw money from the plan.

Published
Categorized as Save

By Adam

Hey, I'm Adam. I started Wonder of Compounding in 2021 to help others learn about financial literacy and achieve their financial goals. I’m a lifelong student and eternal optimist with a passion for investing, technology and entrepreneurship. I’ve worked in the financial services industry for more than a decade. In 2008, I earned my Bachelor of Engineering and Master of Engineering from Stevens Institute of Technology and in 2015, I received my MBA from New York University.

Leave a comment

Your email address will not be published. Required fields are marked *