529 Plans Explained: What You Need to Know Before You Start Saving

Planning for college can feel overwhelming, especially when it comes to saving money. One of the most popular and powerful tools to help families prepare financially is the 529 college savings plan. But what exactly is a 529 plan, and how can you use it to save for education expenses? Here’s what you need to know before you start saving.

What Is a 529 Plan?

A 529 plan is a tax-advantaged savings account specifically designed to help families save for future education costs. Named after Section 529 of the Internal Revenue Code, these plans offer significant benefits that make saving for college more accessible and efficient.

There are two main types of 529 plans:

• College Savings Plans: These work like investment accounts where your money grows tax-free, and withdrawals are tax-free when used for qualified education expenses.

• Prepaid Tuition Plans: These allow you to lock in current tuition rates by pre-purchasing credits at participating colleges.

Why Consider a 529 Plan?

1. Tax Advantages

Contributions grow tax-deferred, and withdrawals used for qualified education expenses are federal income tax-free. Many states also offer tax deductions or credits for contributions, providing extra savings.

2. Flexibility in Use

Funds from a 529 plan can cover a wide range of qualified expenses, including tuition, fees, books, supplies, technology, and even room and board (for students enrolled at least half-time).

3. Control and Ownership

The account owner retains control over the funds, including decisions on investment choices and withdrawals, regardless of the beneficiary’s age.

4. Beneficiary Changes

If the beneficiary decides not to attend college or receives scholarships, you can change the beneficiary to another eligible family member without penalties.

What Are Qualified Education Expenses?

To get the tax benefits, withdrawals must be used for qualified education costs, such as:

• Tuition and fees

• Books and supplies

• Computers and software

• Room and board (on-campus or off-campus if enrolled at least half-time)

• Special needs services required by the beneficiary

Non-qualified withdrawals may be subject to income tax and a 10% penalty on earnings.

How Do 529 Plans Affect Financial Aid?

One common question is how 529 savings impact financial aid eligibility. Generally, 529 plan assets owned by the parent are treated as parental assets on the Free Application for Federal Student Aid (FAFSA), which typically has a smaller effect on aid eligibility compared to assets owned by the student. However, distributions count as student income in the following year, which can affect aid.

It’s important to plan strategically with a financial advisor to balance saving and maintaining eligibility for grants like Pell Grants and scholarships.

Getting Started: Tips Before You Open a 529 Plan

• Research Your State’s Plan: Many states offer their own 529 plans with state-specific tax benefits and different investment options. You don’t have to use your home state’s plan, but it’s often advantageous to consider it first.

• Understand Fees and Investment Options: Look for plans with low fees and a variety of investment choices that fit your risk tolerance and timeline.

• Start Early and Contribute Regularly: The earlier you start saving, the more time your money has to grow. Even small, consistent contributions can add up over time.

• Consider Your Overall Financial Picture: While saving for college is important, don’t neglect other financial goals such as emergency savings and retirement.

Final Thoughts

529 plans are powerful tools to help make college more affordable. Understanding their benefits, rules, and how they fit into your broader financial plan can make your savings journey smoother and more effective. If you’re ready to start saving for college, consider speaking with a financial advisor to tailor a strategy that works best for your family.

*The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that an education-funding goal will be met. In order to be federally tax free, earnings must be used to pay for qualified education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10 percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.