Written by Tom Bakamus, CFP, Wealth Manager
According to research by Best Colleges, the average total cost for a year of college at a four-year school is $35,551 (including tuition and related fees, room and board, books, and supplies). That means four years of college education costs at least $142,000.
The rising costs of college and skyrocketing student loan debt have put post-high school education under a microscope. As a result, 62% of parents say they’re encouraging their kids to look at more affordable colleges, and 50% are considering a change in how they save to prepare financially for their child’s college years.
There are several ways families can prepare for education after high school. One way to save for college, or other schooling, is with a 529 plan. Let’s walk through the basics of 529 savings plans and how they can be used to save for education.
What is a 529 plan, and how does it work?
A 529 plan is a tax-advantaged savings plan designed to help fund education expenses, college, K-12 tuition, and apprenticeships. These plans allow you to invest and save money to help pay for those costs.
The funds in a 529 savings plan can be used to cover the cost of most colleges or universities throughout the country. You can also use a 529 plan to cover other school-related costs, including room and board, — there are certain limits (the amount you can use may be based on how much room and board is on campus), computers or other technology-related expenses, books, and up to $10,000 for repayment of student loans.
Who can start a 529 plan?
Any adult can open a 529 plan; there are no income limitations. However, there are limitations on how much money you can have in the plan (usually between $250,000 – $500,000, depending on your state).
A parent or a grandparent can start a 529 plan, and the child could use money from both. However, there may be financial aid implications for the student based on who owns the plan. A financial advisor can help you identify who should be the plan owner to achieve maximum benefits.
What are the benefits of a 529 plan?
529 plans are one of the most common ways to save for education, but they are still underutilized by many. As of December 2022, there were 15.81 million 529 accounts in the nation with a total of $457.7 billion. On average, Americans have saved $28,953 in their 529 accounts, however 54% of parents are still unaware of 529 plans. 529 plans are chock full of benefits, which I have outlined below:
The investments in the plan grow tax deferred. With a 529 plan, you are not taxed if you were to pull out the funds for a qualified education expense. The amount you can contribute (no maximums – except for within the plan itself) – depends on the state.
The funds can be used nationwide for public or private schools. You aren’t limited to a type of school or its location; you can decide when you’re ready.
You can change the beneficiary to the account. For example, if you have multiple children or another family member who wants to go to school, you can transfer the funds to anyone within your family. The funds don’t expire.
529 plans aren’t just for kids. Regardless of your age, 529 plans can be used for higher education. 28% of parents who are saving for their own education are using 529 plans.
You can transfer the funds to a Roth IRA. The recently passed SECURE Act 2.0 will soon allow the owner of the plan to contribute or transfer funds to a Roth IRA in the name of the beneficiary (starting in 2024), with a maximum of $35,000. Keep in mind that this is subject to annual contribution limits.
You can use 529 plans for estate planning. In 2023, the annual exclusion amount (how much a person can transfer to another without paying a gift tax) is $17,000 per year per person and $34,000 per couple. But with a 529 plan, you can give up to five years at one time, up to $85,000 for a single person and $170,000 per couple. This can help family members that are looking to reduce an estate or offload assets.
Nearly every state offers a 529 plan. The only state that doesn’t have a 529 plan is Wyoming. Washington D.C. also offers a 529 for its residents! As an additional note, you do not need to reside in the state you open the 529 plan with, and you do not have to use the 529 plan funds in the state that holds your plan.
Other important considerations.
There are a couple of other important considerations to keep in mind before you open a 529 plan for your loved one.
- If you don’t use the funds for a qualified educational expense (or rolled into a Roth IRA), you’ll be assessed a 10% penalty.
- You’re limited to the investment options within that state’s plans, typically target-date funds based on when you’ll need the tuition.
When is the best time to start saving for college?
When it comes to saving, it’s ideal to start as early as you can. We see the most significant benefit when the assets have the most time to grow – even if you start small at first and increase your contributions over time.
Regardless of your situation, it’s a good idea to have a plan. Your plan should include not just how you’ll save money but also how you’ll withdraw it. Creating a financial plan is the best way to map out the plan and understand your options for unused savings.
This year, 529 Day is celebrated on May 29. Consider recognizing 529 Day by opening a 529 plan, making a savings contribution, or scheduling a meeting with a financial advisor. For professional help with college savings, contact Merit Financial Advisors today!
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Merit Financial Group, LLC, an SEC-registered investment adviser. Merit Financial Group, LLC and Merit Financial Advisors are separate entities from LPL Financial.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for individualized legal advice. Merit Financial Advisors and LPL Financial do not provide legal advice or services. Please consult your legal advisor regarding your specifics
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program.