College 529 plans have been around for quite a long time – but they are gaining popularity amongst parents who are trying to save for their children’s future education costs.
Besides adding our children as a rider on our insurance policy when they were first born, this is the second thing we did for all of our children – and we continue to contribute. We started them with a lump amount, and then opted to contribute a set amount monthly. It is probably one of the best decisions we have made.
Will our children go to college? That we don’t know – but it’s worth the effort anyways… considering most children don’t have a plan for college and rely on financial aid (also known as student loans), I have always taken the direction of starting them off in a way that helps them stay out of debt, not get into debt. Although we are the only parents in our family, on both sides, who believe in our approach, at least our children will have the option for college *if* they decide.
At best, they will have a college fund and due to diligence and early planning, it’ll likely cover all four years at a public institution if we continue on the course we started.
And if not, then the funds can easily be used for someone else… not entertaining a college fund (for any reason) is a risk – especially considering the costs of college, and the sheer fact that loans are so readily available. Loans are not how we want our kids to start off their adulthood.
Why Put Away for College
A recent study by Sallie Mae shows that 36% of middle income families and 29% of low income families are actually putting away for their kids college fund. Are you one? When referencing college funds and looking at parents, people usually fall in 1 of 3 categories…
- Parents who have established a savings vehicle and contribute regularly to that vehicle for one or more of their kids with intent to pay for their child’s college/higher education
- Parents who have no savings vehicle – either due to the inability to put away or, because they may feel that it makes their children less apt to appreciate the effort it took to save
- Parents who have established the need for a vehicle and intend to HELP their children put away, perhaps not fully fund their college but contribute either half or close to to assist them as much as they can
With that in mind, sometimes putting away can be daunting – many don’t know where to start, they may assume they can’t afford to put away, or they just need that gentle push to get started.
A 529 plan works similarly to a Roth IRA – you make your contributions with after tax dollars and earnings grow tax free. You will not be taxed at withdrawal as long as the money is spent towards qualified education expenses.
529 Plan Differences
There are two types of 529 plans ~ some 529 plans can buy tuition units (priced on the average of cost at public colleges in their state) and then use those later when the student attends school — in that state (Prepaid Tuition Plans).
There is also a 529 College Savings Plan that operates similar to an investment account… that offers investment portfolios that will increase or decrease and are based on the market. That is the type we are referencing in this post today. Both plans allow your contributions to grow federal income tax free – provided the funds are used for qualified higher education expenses. For the investment plan, that covers tuition, fees, room, board, books and even a computer –– IF the school requires the kids to have one.
Here are some of the misconceptions about the College 529 Plan.
#1 – If my Child Doesn’t go to College, I lose all the Money
Not true – you will never lose all that money. Here are some alternatives that might work for your situation:
- Save the funds for a grandchild, or for another family member
- Use the funds to pay for vocational school, trade school or even community college – brush up on some skills, or encourage your children to
- Pay for your own continuing education – after all, it’s never too late to go back to school, right?
#2 -What if my Child gets a Scholarship or Full Ride?
You won’t ever lose all your money... as we mentioned, you can simply transfer to a different beneficiary. If your child gets a scholarship and doesn’t need all the money, you can appropriate that 529 plan to another person in the family – your other child, yourself, your spouse, a nephew, or even a grandchild.
#3 – My Children can only Attend College in the State where the Plan Was Set Up
Thankfully your children can attend almost ANY college, no matter where the 529 plan is based ~ including 4 year public and private colleges, trade schools, and even community colleges. Provided the school is accredited (and you can check the FAFSA site for that) you can use it.
#4 – 529 Plans are for Younger Children Only
Thankfully this is a myth too! :) There are NO age requirements for the 529 plan beneficiary. Although it’s best to start your children when they are young (more time for their money to grow), older children and even adults can take advantage of the tax benefits.
#5 – A 529 Plan will Affect my Child’s Financial Aid
If you plan on receiving some kind of financial aid for your children in the college process, understand that only one out of every 300 students will receive a scholarship for college. This should motivate you more to save for their college. Most aid comes in the form of federal grants (which are not repaid but are for low income families)… and student loans – which have to be repaid.
Unfortunately, to quality FOR federal grants, you must apply FOR financial aid (catch 22…) — even more, your federal grants are mixed in with the aid, making it effortless for our kids to start racking up loans from the onset.
While you can’t control how much aid your child may be awarded or what their loans will be, you CAN be in charge of what you contribute to their education. In terms of financial aid eligibility, up to 5.64% of parent-owned assets are considered in the financial aid calculation. Sure, it will affect their financial aid, but the effects are minimal.
#6 – I Make too Much to Contribute to a 529 Plan
The truth is… that unlike other educational savings accounts, there are NO income restrictions on a 529 plan.
One of the benefits of the 529 plan is the large contribution limits – each state operates its own 529 plan and makes rules for that plan, so contribution can vary across the U.S. Check your local state to determine their state-specific contribution limits. Plan balances cannot exceed the beneficiary’s qualified education expenses. The guideline is usually 5 years of tuition, room and board at the most expensive college in the U.S. (which makes the limits quite large).
#7 – The 529 Plan is a Use-It or Lose-it Savings Vehicle
This couldn’t be more incorrect – though it is a popular misconception, many may not understand exactly what happens if your child opts not to go to college. If your child opts against college, then transfer the plan to another beneficiary – which is entirely too easy to do.
If you end up withdrawing the 529 funds to make non-qualified purchases, you will incur income tax and a 10% penalty on the earnings ONLY portion of your account – your gains. The principal portion (which is what you originally contributed) will NOT be taxed or penalized because it was contributed by you with after-tax money.
If you want to avoid those taxes, you can change the beneficiary to another family member who is planning on college. Or make yourself the beneficiary. OR, save the 529 plan for your grandchildren – it’s a educational legacy, so it can be passed down through multiple generations.
#8 – Once my Child is Legal Age they can Run Of with the Money
Thankfully that is NOT the case! The account owner of a 529 plan retains control of the 529 plan through the life of the account. Even once the beneficiary becomes an adult, they still don’t hold any rights to the funds.
#9 – You Need to Be Rich to Put Away in a 529 Plan
That couldn’t be more incorrect – in fact, it’s relatively easy to open one up for the kids, or even for yourself. Some afford the ability to start with as little as $25 per month.
Before you rush to open up an account, you want to be aware of how they work, and read about some of the common mistakes that people make when opening up a 529 plan for their children.