What is a 529 plan?
How can they help pay for higher education?
A 529 plan is an education savings plan that offers tax benefits and financial aid benefits. A college savings plan is an investment vehicle that is meant to encourage people to save for their children’s future higher education expenses. According to Statista, there are approximately 5.3 million households that own at least one 529 plan.
There are two types of 529 plans, including prepaid tuition plans and education savings plans. Prepaid tuition plans are plans through which parents can purchase future education credits at participating universities at today’s prices. Prepaid tuition plans cannot be used to pay for future elementary or secondary school costs.
Education savings plans are investments that can be set up and used to pay for the costs of higher education at any college or university. In addition to tuition and books, education savings plans can also be used to pay for room and board. People are also allowed to withdraw up to $10,000 per year from education savings plans to pay for private school tuition at primary and secondary schools.
Should I open a 529 plan?
College savings plans might sound like a great idea so that you can save money to defray the costs of your child’s future college education. However, some experts recommend that you forgo investing your money in a 529 education plan for your children if it interferes with your ability to save for your retirement.
Another option might be to open a Roth IRA instead of a 529. You are able to withdraw the contributions that you make at any time from a Roth account without incurring penalties. When you compare a Roth IRA vs. 529 plan for college, you may find that you have more investment choices with a Roth than you might have with even one of the best 529 college savings plan.
How to start a 529 plan
If you are wondering about how to start a 529 plan, there are five steps that you can take. The first step is normally the most difficult because it involves you choosing your plan. Forbes reports that there are more than 100 college savings and prepaid tuition plans available. A registered education savings plan works in a similar way as a 401(k) plan. By contrast, a prepaid tuition plan grows at a rate that is guaranteed and may be limited to residents of a state or to specific public universities in a state.
Some of the best 529 plans have high lifetime contribution limits and allow the money to be used at any college or university. If you are wanting to find one of the best education savings plans, you need to spend some time researching.
After you have figured out the type of plan that you want to open, you will need to decide if you want an in- or out-of-state option. If your state offers a 529 plan tax deduction, an in-state plan might be a better option. After you have chosen your plan, you can open it and fund it. This is all you need to know about where to open 529 plan and the answer to “how do I open a 529 college savings plan.”
College savings plans
College savings plans act in a similar way to a Roth IRA. These types of plans allow you to open an investment account to save money for your child’s K-12 tuition or for his or her future anticipated higher education costs. You make the contributions on an after-tax basis. When you make withdrawals in the future for qualified expenses, you will not have to pay any taxes or penalties.
Comparing a Roth IRA vs 529 plan for college expenses reveals that a Roth IRA might offer greater flexibility. With a Roth IRA, you can make withdrawals of your contributions at any time just like you can from a savings plan for college. However, the investment choices that are available for a 529 might be more limited than what you can choose with a Roth IRA.
If you are trying to decide between a 529 plan vs. IRA for your child’s college expenses, a 529 may be the better choice. This is because you cannot withdraw money from a traditional IRA prior to when you reach age 59 1/2. If you do, you will have to pay a 10 percent IRS penalty and taxes on your withdrawals.
The contributions that you make to a savings plan will be invested in mutual funds or other securities. The performance of your plan may fluctuate up or down with the performance of the investments that you have chosen.
When it comes time to withdraw money from a savings plan, it is important that you make certain that the money is used only on qualified expenses. If you are wondering, “Can I use my 529 plan to pay student loans?” the answer is no. Student loans are not a qualified expense. If you spend money from your plan to make student loan payments, it will be counted as a non-qualified withdrawal, subjecting you to penalties. You can use the money to pay for your tuition, books, fees, supplies, and room and board, meaning that you might be able to avoid taking out student loans in the first place.
Prepaid tuition plans
A prepaid tuition plan is a type of 529 plan in which you purchase credits through your state or through participating institutions for your child’s future college tuition costs. The state guarantees that the credits that you purchase in today’s money will be worth the same number of credits for your child in the future.
For example, if you buy a year’s worth of credit hours in today’s money at a participating university, a prepaid plan guarantees that the money that you invest in the plan will be worth a year’s worth of credit hours when your child attends college. Prepaid plans may be limited to residents of a state or to specific institutions within that state.
You can designate anyone as a beneficiary of a prepaid plan. While you can be the only owner, anyone who wishes can contribute to the plan. The prepaid plan operates more like a pension because of the guaranteed benefits. Unlike a college savings plan in which the value can increase or decline with the market, a prepaid plan provides a guarantee of the money that will be available in the future.
College savings plan vs. prepaid tuition plan
Most prepaid plans offer the following features:
- Guaranteed by the state
- Has tax advantages
- Does not cover room and board
- Does not offer investment choices
- May have age limits
- May have grade requirements
- May have residence requirements
- Cannot be used at any school
- Will charge penalties for non-qualified expenses
Savings plans have the following features:
- Not guaranteed by the state
- Offers tax benefits
- Pays for room and board
- Offers investment choices
- Does not impose age limits
- Does not have grade requirements
- May be used at any school
- May be used for K-12 tuition
- Does not have residence requirements
- Will charge penalties for non-qualified withdrawals
What does college cost, and how much will it cost in the future?
When you are trying to plan ahead and learn how to pay tuition with 529 plan, it is important for you to consider both what college tuition, room, and board costs now and what it will likely cost when your children reach college age. You should not save with only today’s costs in mind and should instead plan how to pay tuition with 529 plan according to the estimated future costs.
The College Board reports that the average costs of college attendance during the 2018/2019 school year are as follows:
- Public two-year college: $3,660 per year
- Public four-year college: $10,230 per year
- Private non-profit four-year college: $35,830 per year
It is important to note that these are only averages. Your child might choose to attend an institution that costs more or less than the estimates that the College Board provides. The estimates can give you a rough idea, however.
To gain a rough estimate of how much you might need to save in a college savings plan for future college costs, you can use a calculator. The College Plan Savings Network offers a free calculator that you can use to figure out what you might expect to pay when your child is ready to go to college.
Fees on a 529 plan
Before you invest in a college savings plan, it is important for you to check the fees. Every college savings plan charges fees, and it is important for you to understand how those fees will reduce the earnings that you realize.
You can look at the disclosure statements of a college savings plan to see the fees that the education savings plan charges. For state 529 programs, you can find the disclosure statements by going to their websites. Some education savings plans include the disclosures under their enrollment information tabs.
Once you understand the fees, you can input data for two education savings plans to compare how their fees will impact your 529 plan returns. Finra has a free 529 college plan calculator that allows you to input data about two separate college savings plans so that you can see how the fees might affect your earnings.
Taxes on a 529 plan
The contributions that people make to 529 education savings plans are made on an after-tax basis. The earnings within the 529 education savings plans grow on a tax-deferred basis. You will not have to pay any taxes on the distributions if you use them to pay for qualified educational expenses.
If the beneficiary takes a non-qualified distribution from the 529 plan, the distribution will be taxed at his or her tax rate. Distributions that are made for non-qualified expenses may also be subject to a 10 percent tax penalty unless an exception applies.
There are several exceptions to the 10 percent tax penalty rule, including the following beneficiary situations:
- Passes away
- Becomes disabled
- Receives veteran’s assistance
- Receives scholarships
- Receives employer tuition assistance
Federal policies on 529 plans
Every state has its own regulations governing 529 plans. There are also certain federal policies that apply to college savings plans in every state. These federal policies apply whether you invest in a 529 plan through your state, from an advisor, directly, or purchase a national plan.
The owner of a college savings plan can only be one person. There cannot be multiple owners of a 529 college savings plan. However, one person can own several 529 college savings plans. It is important to note that the money contained in the different 529 college plans cannot exceed your state’s contribution limits in aggregate.
Anyone is allowed to make contributions to a 529 college savings plan. A single 529 college savings plan can only have one beneficiary. If you have more than one child, you will need to open separate 529 plans for each one.
Your income is not limited to open and contribute to a 529 education savings plan. You will only need to worry about the federal 529 plan gift tax if your estate will be worth more than $11,400,000 when you pass away. However, your state may have a lower gift tax exclusion for gifts that you make during your lifetime.
How to withdraw money from 529 college plan
It is simple to fund a 529 college plan with money. When it comes time for you to withdraw money from the plan, you must do so in the correct way. If you make a mistake in how you withdraw funds from your 529 account, you might be assessed a 10 percent 529 plan withdrawal penalty.
You should only withdraw money to pay for expenses that are qualified. Some of the qualified expenses include the following:
- Room and board in on-campus housing if you are enrolled at least half-time
Fees that you withdraw must be spent during the same calendar year, and you should save all of your receipts. Can a 529 plan be used for graduate school? As long as you attend graduate school at an eligible university and use the money to pay for your tuition, fees, and other qualified expenses, you can use the funds to pay for graduate school.
The Tax Cuts and Jobs Act allows you to withdraw money from a 529 account to pay for elementary and secondary school tuition. However, you can only withdraw $10,000 per year to pay K-12 tuition expenses. Some state 529 programs do not allow withdrawals to pay for K-12 tuition costs, however. You will want to check with your own state’s 529 program to see if these types of withdrawals are allowed. There is a myth that you can use funds from a 529 to pay for the expenses related to homeschooling your children. However, the TCJA does not allow you to use a 529 plan for homeschool expenses.
Restrictions and 529 plan contribution limits
The IRS does not set annual contribution limits for 529 plans. Instead, each state that sponsors a 529 program establishes the lifetime contribution limits for 529 plans. 529 plan contribution limits vary by state, ranging from around $200,000 to more than $500,000.
The contribution limits are for the entire life of the 529 plan, and the limits apply across plans. This means that if you open two different types of 529 accounts for your child, the total of your contributions cannot exceed your state’s contribution limits. If you contribute too much, you may face a penalty.
There are usually restrictions on any 529 plan that you consider. Education savings plans limit your ability to choose your investments. Most will have a few pre-selected options, and you can only switch investment options twice per calendar year under IRS rules.
Other restrictions may also exist. It is important that you read any 529 plan disclosures carefully to make certain that you understand the restrictions and are comfortable with them.
There are restrictions on withdrawals with all education savings plans. You can only make withdrawals to pay for qualified expenses. If you make a 529 plan non-qualified early withdrawal, you will be assessed a 529 plan withdrawal penalty.
Beneficiaries of college savings plans
Every college savings plan will have a designated beneficiary. The beneficiary of a college savings plan will normally be the child for whom a parent intends to provide funds for educational purposes.
In most cases, a 529 plan beneficiary will not have to attend college in the state that is sponsoring the college savings plan. However, it is important for you to check the rules of a college savings plan before you set up an account.
You will not face any tax consequences for changing the designated beneficiary of a 529 plan to another family member. Funds from the plan will not be taxed if they are rolled over to another plan for the beneficiary or for another family member.
529 plans and student financial aid
If you have money in a 529 plan, it might impact your child’s ability to qualify for need-based financial aid. However, different educational institutions treat 529 account savings differently, meaning that your child might still be eligible for certain types of aid at some colleges.
For many families, student loans make up the bulk of the financial aid that their children receive to pay for college. If you have a 529 plan for your child, you can reduce his or her need to apply for student loans. This can help your child to avoid going into debt so that he or she can start adulthood and their career without being saddled with thousands of dollars in student loans that must be repaid.
How investing works with M1 Finance
When you invest with M1 Finance, you can open an investment account without the added fees and commissions. You can also personalize your individual portfolio to meet your specific needs. You are able to choose the investments that you want to create a custom portfolio according to your risk tolerance.
Automatic transfers are another simple investing feature at M1 Finance. The money that is deposited will be automatically divided between your different investments and rebalanced so that you can invest in an efficient way. M1 Finance automates the investing process to make good financial habits effortless. You can set an investing schedule to fit your financial needs, and your contributions will be automatically invested exactly how you want.
The benefits offered by M1 Finance
As reviewed in Bloomberg, M1 Finance does not charge any management fees or commissions on your investments. This free investing platform allows your money to grow over time, depending how you are invested. The M1 system is designed to make investing accessible to everyone by providing straightforward access to powerful automation for free.
M1 offers many different types of investment products from which you can choose. You are also able to borrow up to 35 percent of the money in your portfolio and pay it back over time. Sign up now to get started investing or call our helpful customer service at 312-600-2883.