529 Plans: Investing in Your Kid’s Future

Written By:


529 College Savings Plans: Investing in Your Child's Future

How 529 plans can help you face those dreaded college bills

The economy is weak. Unemployment is high. And with universities projecting price increases of 10 percent or more per year, just the thought of your child’s future college bills is enough to make your head spin. According to recent articles, the average state college bill is now approaching $40,000 for a four- to five-year degree. And that same $40,000 is about the average for just one year at the top private universities. Ouch!

But don’t send those kids off to bartending school just yet. 529 plans, if you haven’t heard of them, offer some great tax incentives and even ways to collect ‘free money’ to save for your children’s higher education.

What are 529 plans?

A 529 is a state-managed college savings account with benefits – really great benefits. Congress originally created 529 plans in 1996. And in 2006 when they made the tax benefits permanent, 529s became a no-brainer investment for any family that has college plans in their future.

There are two types of 529s: savings plans and prepaid tuitions plans. The first type, a prepaid tuition 529, lets you to (you guessed it) prepay tuition now. While the plans vary a bit from state to state, in general if you pay for half a year’s tuition now, you’re basically paid up for half a year’s tuition that can be used in the future – even 20 years from now. This effectively allows you to “lock in” at today’s tuition rates. And with college costs increasing 10 percent or more per year these days, that’s a bargain any way you look at it.

The second type is called a 529 savings plan, and it’s simply an investment account. Each state offers different investment options – the same kind you’d find at Vanguard, Bank of America and other financial institutions. Opening a new 529 is about as easy as setting up a savings account at your local bank – and many require as little as a $250 deposit to get started.

[Check Your Credit: Don’t Guess. Know.® Get your free credit report and score. No credit card required.

So what’s the big deal about 529s?

Here are the best reasons to open and regularly contribute to a 529 account:

Your own little tax haven – A 529 savings plan allows you to take tax-free distributions on investment earnings used for education-related expenses (room, board, books, tuition, etc.).

Here’s a quick example: say your $10,000 investment in a 529 savings plan earns an average of 5 percent per year for 10 years. That’s about $6,300 in earnings. You can withdraw that $6,300, tax-free, for qualified educational expenses. If you would’ve made that same investment in a normal (non-529) account, you’d have to fork over a portion of those earnings in the form of capital gains taxes. This ‘tax haven’ status is the most attractive, moneywise benefit of 529 accounts. Also, if you live in one of the 35 states that allows credits for 529 contributions, you may qualify for a state income tax deduction. Starting to see why these plans are great?

You don’t have to kiss that scholarship goodbye – Just because your kid has a well-funded 529 account will not disqualify them from scholarship or financial aid opportunities. 529 accounts are considered parental assets (not the beneficiaries’) and are assessed at a maximum of 5.64 percent rate, which means your child’s financial aid qualification will only be impacted by a maximum of 5.64 percent of the total balance of the 529 account.

Lots of choices – Your plan choices aren’t limited to your state of residence (although if you do get a state income tax deduction incentive, it may make financial sense to stick with your home state plan options). For example, I live in Texas but my kids’ 529 plans are with the state of Nevada (managed by Vanguard). When I comparison shopped, the Nevada plan best matched what I was looking for in terms of investment options and flexibility. And since I don’t have to worry about state income tax (Texas doesn’t have one, yee-haw!), my choice was clear. You can compare plans for each state here.

Also, 529 plans are portable, so if you have an account sponsored by the state of Nevada or Oklahoma or Delaware, it doesn’t mean your child has to attend a university in that particular state.

Did someone say free money? – There are lots of rewards programs – like Upromise and others – that allow you to earn rebates on credit card purchases that can be deposited into your 529 account. You can earn as much as 2 percent on purchases with some cards and several have no caps on the rebate levels. That’s free money, and we definitely like that!

OK, so what’s the downside?

We all know nothing’s perfect, and 529s are no exception. First, your investment options are limited to what a state’s program has to offer. That said, though, there are so many programs nowadays that this is less of an issue than it was in the past.

Another possible downside is that if you withdraw funds from the account for any reason other than approved education-related expenses (also called ‘non-qualified distributions’), you face a 10 percent withdrawal penalty. Non-qualified distributions are also taxed like any other non-529 investment – meaning you don’t get the tax-exemption on the gains. Note, however, that there are some allowable exceptions to the 10 percent penalty, like death of the beneficiary or if your child gets a scholarship and no longer needs the funds.

Those are the main disadvantages, and in my opinion they’re not even close to deal breakers – the pros absolutely outweigh the cons.

When it comes to your children’s education, it’s hard not to get a knot in your stomach thinking about those huge college bills that will be coming your way someday. But with a little homework and planning, taking advantage of the benefits of a 529 account can help you build a solid foundation for your child’s future.

[Check Your Credit: Don’t Guess. Know.® Get your free credit report and score. No credit card required.

For more tips and tools to help you financially prepare for the future, check out Quizzle.com, where you’ll get access to a Credit Personal Trainer to make sure you can qualify for private student loans should you need them and a Debt Planner that will help you get out of debt faster so you can start saving.

Related articles: