Prepaid plans allow you to pre-purchase “units” of tuition at rates similar to today’s. They are cashed-in when the student attends school. 529 college savings plans are built so you can invest in portfolios that make gains (or losses) based on the performance of the underlying assets in the plans.
Most states offer 529 college savings plans, only a small handful offer the prepaid option. Both can also be sold by independent brokers and both come with operating fees and operating costs ranging from 0% - 2% depending on a number of factors.
529 college savings plans earnings are tax-deferred. If the money in the account is used to pay for higher education expenses, as it’s intended, it can be entirely tax-free. Before locking yourself into one plan or another, check to see if your state-sponsored plan offers additional benefits; many come with tax credits or grants that can help further offset costs.
According to the IRS, “Qualified expenses are amounts paid for tuition, fees and other related expense for an eligible student that are required for enrollment or attendance at an eligible educational institution.” These can include activity fees to fund all on-campus student organizations and activities. Expenses for books, supplies, and equipment the student needs for a course of study are included in qualified education expenses even if it is not paid to the school. See the IRS Education Credits: Questions and Answers for more specifics.
Note that room and board, insurance, medical expenses (including student health fees), transportation and similar personal, living or family expenses do not qualify.
529 assets can be used at any eligible institution of higher education, not just 4-year colleges. Whether your child wants to be a computer programmer or cosmetologist, an artist or an EMT—just about any post-secondary training can be paid for with a 529 plan without penalty. Check with the school before confirming.
Thanks to compound interest, even small contributions can add up over time. For example, a $500 starting contribution + $200 added monthly, at 6% interest over 18 years = $77,000 for college. Much like retirement accounts, the sooner you can get the plan set-up and start building, the better.
Many plans make it easy to continue adding funds with automated contributions that can be drawn from other accounts at the intervals of your choosing.
It’s true that 529 plans will have an impact on how much much financial aid a student may qualify for, but not as much as funds stored in some other types of accounts. According to the Department of Education, every dollar stored in a 529 account in a parent’s name will subtract up to 5.6 cents from your family’s federal need-based financial aid package. By contrast, funds stored in checking and savings accounts in a child’s name will subtract up to 20 cents per dollar from federal financial aid.
When setting up the account, you’ll select a beneficiary, the person you’re saving for. You’ll want to have their social security number handy to make the process easy.
But what if that person decides against higher education? You still have a number of options:
Change the beneficiary to a sibling or other qualifying family member who will attend college.
Use the money to pay for your own continuing education.
Save the funds for a future grandchild.
Take a non-qualified withdrawal and pay income tax and a 10% penalty on the earnings portion of the withdrawal.
Looking for the right plan to start saving? We recommend starting at Savingforcollege.com.
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