If you’re a parent, chances are you’ve thought about the cost of college – even if your child is still in diapers! And with the cost of tuition and room and board steadily on the rise, affording college can seem overwhelming and unrealistic for many. The good news, is that it’s never too early to start saving for a college education, and there is a specific type of savings plan that can help you do exactly that.
One popular savings vehicle for college expenses is a 529 plan
. With a 529 plan, you deposit money into an investment account that you set up on behalf of the student (also known as the beneficiary). The money you deposit into a 529 plan won’t reduce your taxable income – like deposits made into a 401k - but when you withdraw funds down the road to pay for college, the investment earnings in your plan will not be taxed. In other words, your money can grow tax-free; that is, as long as the withdrawals are used for qualified education expenses. 529 plans can typically be used to cover college education costs such as tuition and fees, room and board, required textbooks and other class supplies, as well as necessary technology like computers, internet service plans, and printers.
If 529 plan withdrawals are used for non-qualified expenses, you could face a penalty in addition to having to pay taxes on any earnings in the account. It’s important to note that you can always withdraw the money you originally invested without penalty, however any gains you’ve made off of that initial investment will be subject to taxation and a 10% penalty fee if the expenditures are deemed uncovered and non-qualified.
One concern parents have with 529 plans, is what happens to the money in the account if their child doesn’t end up going to college. In addition to being able to withdraw your principal (the amount you invested minus any investment earnings) without incurring a penalty fee, parents facing this type of situation may have a few other options as well. To start, there are some withdrawal exceptions with 529 plans that allow for non-qualified withdrawals. In the event that the student receives a scholarship, dies, or enrolls in a U.S. service academy instead of college, parents can withdraw from the 529 plan without having to pay the 10% penalty, however they will still have to pay taxes on any earnings.
If the student beneficiary decides not to attend college, another option is to change the beneficiary to another child. In this case, the other child can utilize the full amount of the 529 plan for qualified expenses, tax-free and without penalties, when they are ready to attend college.
offer their own 529 plans, including Massachusetts
and Rhode Island
. Plan rules, including minimum contribution requirements, and lifetime contribution limits, vary by state, so it’s a good idea to review your state’s plan in detail. It’s also worth noting that you don’t have to
go with your own state’s plan.
And unlike other tax-advantaged accounts, like IRAs and 401ks, the IRS doesn’t have a specific annual contribution limit for 529 plans. Some states do set their own limits, but they’re typically quite high (for some states, they’re as high as $300,000 or more per year). You should keep in mind however, that if you contribute an annual amount that exceeds the gift tax exclusion (which is $15,000 for 2018), you will likely have to file a gift tax return
(although having to file a gift tax return doesn’t necessarily mean that you’ll owe the IRS any additional money).
Another helpful aspect of 529 plans is that families can now use them to pay up to $10,000 per student, per year, in tuition expenses at private K-12 schools. These changes became effective January 1, 2018 as part of The Tax Cuts and Jobs Act. Prior to this change, parents looking to save for private grade school or high school tuition usually had to go with a Coverdell Education Savings Account, rather than a 529 savings plan.
And, if your beneficiary is undecided about attending college immediately after high school graduation, there’s no reason to panic. You can leave funds in a 529 account until they’re needed, since there’s no penalty for taking distributions beyond the age of 30.
A 529 plan can be a great way to invest in your child’s future, but remember that it’s always a good idea to consult with a tax advisor or financial professional before making any major investment decisions. If you’re interested in learning more
about whether a 529 plan might be a good fit for your education savings goals, contact BankFive