529 plans are an investment option, similar to a 401(k), with tax incentives and defined investment choices.
A big difference is that you don’t have to work for a company to invest in such a plan. You can sign up for one from your state or get another state’s plan.
“The biggest barrier to saving for college in a 529 plan is the fear people have in thinking enrollment is complicated,” says Betty Lochner, former College Savings Plan Network executive director and current spokesperson on the national 529 campaign.
“You can enroll in most plans in minutes and with simple investment options based on age or purchase prepaid tuition in order to save money on future higher education costs,” Lochner says.
In this article, you’ll learn why to save in a 529 plan, whether you want one that also guarantees future tuition rates, and how to optimize tax benefits to boost college savings.
Why Parents Should Save in a 529 Plan
529 plans are special accounts authorized by Congress to help families set aside money for college. They are available in all 50 states to parents, relatives or anyone who happens to have the desire to save for a child’s or their own education.
Since so many people invest in them and there are billions of dollars in contributions, these plans are able to offer lower fees than if you were investing individually.
They grow, state and federal income tax free, and 34 states offer state tax deductions or credits for contributions.
What’s the Difference Between 529 Savings Plans and Prepaid Tuition Plans
There are two types of 529 plans: savings (investment) and prepaid tuition.
529 savings plans allow families to save for college with tax savings but are subject to the fluctuations of the stock and bond markets, where assets are generally invested.
They contain a small selection of investment options similar to a 401(k) to keep investing simple.
Whereas, prepaid tuition plans guarantee future tuition for what you paid today without the risk associated with potential market fluctuations.
For instance, if you’re guaranteed $500 worth of tuition at today’s prices and you use it in five years when tuition for that same portion is worth $600, you’re guaranteed to save $100.
Families in about a dozen states have prepaid plans to finance college at state colleges, but there is also a plan operated by nearly 300 private colleges and universities that is available nationwide called Private College 529 Plan.
How 529 Tax Incentives Can Help Increase Your College Savings
When you invest in a 529 account for your child’s future, earnings are tax free if used to pay qualified education expenses. That’s a crucial benefit of a 529 account.
For instance, let’s say you invested $1,000 in an ordinary investment account and it grew over five years by $500.
If you paid 15 percent taxes on the growth, you’d owe $75 on the investment earnings.
With your savings in a 529 plan, Uncle Sam lets you keep all of your earnings to pay college expenses. Unlike some tax provisions, that’s true no matter how high your income is.
Make sure to check with your state to see if you have to choose its own plan to qualify for your state’s income tax deduction or other income tax incentives. Six states allow you to claim the tax deduction if you invest in any 529 plan. Sometimes it might be better to use another state’s plan to take advantage of lower fees or better investment options.
Tracy J., a member of the Paying for College 101 Facebook group, was happy to learn that her state’s income tax deduction was per person and per child.
Over the course of saving for the education of their children for more than a decade, she and her husband were able to save thousands on their taxes.
Another group member, Beth T., used various tax savings strategies, including the American Opportunity Tax Credit, to help pay for her student’s education.
This credit allows many middle-income families to get back up to $2,500 annually in tuition payments, if they qualify.
Because it’s considered “double dipping” on federal tax incentives, these tax credits are only on tuition that has not been paid for with 529 funds.
How to Boost Savings With Gifting From Family and Friends
Most 529 plans have an option to provide a link to your account for family members and friends who want to donate to your student’s education.
A family that throws a birthday party where 10 people contribute $25 each would earn $250 for college savings from just that one event.
You can send the link to family members, post it on your social media accounts or add it to graduation and birthday announcements or event invitations with a note encouraging college fund contributions in lieu of gifts.
529 Basics Checklist:
- You’ve researched the different plans available using the CSPN network’s website.
- You know the difference between a prepaid plan and a traditional 529 plan.
- You’ve looked up tax incentives for 529 plans on your state tax department’s website.
- You’ve reviewed ways to let family and friends know that they can contribute to your child’s college savings plans in lieu of other gifts.
Use R2C Insights to help find merit aid and schools that fit the criteria most important to your student. You’ll not only save precious time, but your student will avoid the heartache of applying to schools they aren’t likely to get into or can’t afford to attend.
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