With costs of higher education so significant, families benefit greatly when they can start saving for college early. There are many ways to set aside those funds, but 529 plans are one of the most common financial tools. Here’s what you need to know about these savings accounts.
Basics of 529 plans
A 529 plan is a tax-advantaged college savings account. Each account has one designated beneficiary, which is typically the future student. If you’re over 18 years old, you can open a 529 account for yourself, but these accounts are usually set up by a parent or grandparent to benefit a child. However, non-relatives can open one or contribute to an existing 529 account (there’s no limit to how many plans you can set up).
Although 529 plans are usually sponsored by states, you don’t have to use one in your state and the beneficiary doesn’t have to attend college there to be eligible. If another state offers a plan with better features, you can sign up. Note that some states let 529 plans cover graduate school, while others don’t.
There are two basic types of 529 plans: prepaid tuition plans, which lock in tuition rates at in-state, public schools and college savings plans, which are more flexible but don’t lock in tuition rates.
The money can be spent on qualified expenses for higher education at most of the country’s accredited colleges and universities (plus some foreign schools).
Benefits of 529 plans
There are no income restrictions for contributors or beneficiaries, so anyone can open and put money in a 529 plan. Additionally, the account holder generally gets to decide how to invest the money saved.
Best of all, the earnings on the money are exempt from federal taxes — and possibly state taxes — if used for qualified education expenses. These typically include room and board, tuition, fees and books.
Downsides of 529 plans
Know that having a 529 plan can reduce a student’s eligibility for need-based financial aid for school. This may not affect you, but take it into consideration if significant loans or scholarships may be needed.
Although withdrawals on eligible expenses aren’t subject to federal (and sometimes state) taxes, contributions are not tax deductible. States generally set limits for how much can be contributed so it doesn’t exceed what’s actually needed for education expenses. Additionally, contributions over $14,000 annually may be subject to gift tax, the Internal Revenue Service says.
Some 529 plans have expenses and fees associated with the investments, including fees for account maintenance, if you’re a nonresident or if your balance gets too low. Before you open an account, review the fee schedule to make sure it’s the right fit.
Although 529 plans can affect aid eligibility and come with some restrictions and potential fees, they can be a helpful way to help ensure a loved one has enough money for college.
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