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By the time babies born in 2016 turn 18, the cost of their college educations may top $200,000. That’s if they attend an in-state, four-year public university and the $20,000 the College Board estimates they’d pay today for tuition room and board rises at an average of 5% annually. One tool parents can use to save for these costs is a 529 plan. The name comes from the Internal Revenue Code section that authorizes the plans, legally known as “qualified tuition programs.” Most plans are sponsored by a state or state agency.
Flexibility is king
Just about anyone can open a 529 plan. The account holder can name anyone, including a child, grandchild, friend, or even him- or herself as the beneficiary.
Investment options for 529 plans typically include stock and bond mutual funds, as well as money market funds. Some plans offer age-based portfolios that automatically shift to more conservative investments as the beneficiaries near college age.
Earnings in 529 plans typically aren’t subject to federal tax, so long as the funds are used for the beneficiary’s qualified educational expenses. This can include tuition, room and board, books, fees, and computer technology at most accredited two- and four-year colleges and universities, vocational schools, and eligible foreign institutions. Many states offer full or partial state income tax deductions or other tax incentives to residents making plan contributions. In certain instances, the benefits extend to nonresidents who’re subject to tax in the state.
You’re not required to participate in your state’s plan. You may find you’re better off with another state’s plan that offers a wider range of investments or lower fees. Similarly, you can invest in a plan from one state, yet the plan’s beneficiary can attend college in another. For example, you may live in Ohio and invest in a plan from Colorado, while the plan’s beneficiary attends school in Florida.
The downsides
While 529 plans can help save on taxes, they have some downsides. Amounts not used for qualified educational expenses may be subject to taxes and penalties. A 529 plan also might reduce a student’s ability to get need-based financial aid, because money in the plan isn’t an “exempt” asset. That said, 529 plan money is generally treated more favorably than, for instance, assets in a custodial account in the student’s name.
Just like other investments, those within 529 plans can fluctuate with the stock market. And some plans charge enrollment and asset management fees.
Work with a pro
Because the rules surrounding college savings plans can be complex, work with your financial advisor. He or she can help you determine your best options