As college tuition rates continue to climb, more people are using 529 plans than ever before.
You may be wondering what a 529 plan is. Simply put, a 529 plan is a tax-advantaged savings account that can be used to pay for qualified educational expenses.
While most states allow you to save up to $300,000 in a 529 plan, it can be difficult to come up with the extra cash. The average tuition costs for the 2017-2018 school year was $8,230 for public schools and $33,250 for private schools, according to a study by College Board. And that’s just cost per year.
That’s a lot of money to come up with. And most Americans have other financial priorities, saving for retirement, paying health insurance, and paying off debt.
Regardless, there are many advantages of a using a 529 college savings fund. Here’s everything you need to know about college savings plans and whether you should start using one.
How Do You Use a 529 Plan?
529 plans are sponsored by the states. Each state works with various financial institutions to administer their 529 plans. The rules and offerings vary by state, so it’s important to research in advance to ensure you are complying with your state’s regulations.
As a note, you don’t have to use your own state’s 529 plan, but there may be tax advantages for doing so. This directory from Saving for College can help you find the best state plan for you.
Contributions to a 529 savings plan are made post-tax, so when you go to withdrawal your funds for qualified educational expenses, your withdrawals with be completely tax-free. The other major advantage of 529 savings plans is that you won’t have to pay any taxes on your interest earned from your investments, so long as you use the funds for qualified educational expenses.
Qualified educational expenses include tuition and fees, room and board, computers, books, and other college related expenses.
Types of 529 Plans
There are two types of 529 plans – either college savings plans or prepaid tuition plans.
College savings plans work similarly to a Roth IRA or Roth 401(k) by using post-tax contributions. This plan will give you several investment options to choose from.
Prepaid tuition plans let you pre-pay all or a portion of the costs for an in-state public college. For those interested in attending private or out-of-state schools, the prepaid tuition plans can often be converted to be used in these circumstances. Educational institutions can offer a prepaid tuition plan, but they cannot sponsor a college savings plan.
Should You Contribute to a 529 Plan?
It never hurts to contribute to a 529 plan if you plan to contribute to your children’s education.
However, it’s vital that you have other financial priorities in order before you start significantly contributing to a 529 plan.
You are your most important financial priority. While it isn’t ideal, there are plenty of options to finance an education if need be. On the other hand, there are no options to finance your retirement. You need to prioritize saving for your own future before you can save for someone else’s.
If you have debt, it’s a good idea to give that precedence before a 529 plan. Likewise, a fully stocked emergency fund is a necessity.
If you’re overwhelmed with the idea of saving for your children’s college education, the key is to start small. As time goes on, you may find that your other financial priorities balance out and you can up your 529 contributions.
The other factor to consider is how much of your children’s education you want to finance. After some number crunching, you may find that it’s not a possibility to pay for 100% of all of your children’s schooling, especially if they choose to go to a private or out-of-state college.
It’s okay if you can’t come up with the funds to pay for their entire schooling. Between scholarships and student loans, there are alternative ways to pay for a college education.
If saving money for college is a major priority for you, figure out what you can base your savings rate on. For instance, if it’s important to you to pay for your child’s entire education, then look at projected tuition rates and multiply that by four to figure how much the cost would be for their entire education. You’ll have to make a lot of assumptions here – you’re assuming your child will go to an in-state, public school and will graduate in four years’ time. You will also have to assume an average rate of return you expect to earn on your contributions. And you’ll have to guess at what the tuition increases will be throughout the years.
Overall, no matter what you can contribute, a 529 plan is a great way to save money for college if you have the funds available to do so. The important thing is to communicate with your children early on so they know what they can expect when it comes time to look at colleges.
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I opened a 529 for my son when he was born – or rather, when he got his social security number. It hasn’t grown much yet since he’s only five months old now!
Oh wow! That’s great that you have some funds socked away already for a 5 month old! That will definitely help him out with college expenses in the future.
Some of the students at my school have 529 plans. Their parents were smart. Those students will graduate from college without student loan debt.
It’s a great plan if you can manage to save a little more. We don’t have kids yet, but this is something I enjoy learning about so we can set up a strategy for the future.