The big birth day may be months away, but with baby on the way, it’s never too soon to start planning for the future. The U.S. Department of Agriculture currently estimates the cost of raising a child to be $233,610, which includes food, housing, transportation, health care, clothing, child care, basic education and miscellaneous expenses. Notice what it doesn’t include? College savings.
When it comes time for baby to leave the nest and head toward higher education, get ready for a hefty price tag of more than $215,000, according to SavingforCollege.com. For some, that’s like saving for the cost of a second home at a time when the baby budget might already be busted.
But don’t dash your child’s college dreams before they’ve even begun. No matter what condition your wallet and bank accounts are currently in, a 529 plan could one day mean an advanced degree for your baby-to-be.
What is a 529 Plan?
A 529 plan, also known as a “qualified tuition plan,” is a college savings plan sponsored by states and various educational institutions, which is exempt from federal taxes and sometimes state taxes. The funds saved can be used to meet most expenses at qualified universities and post-secondary institutions, with your college choice not affected by the state from which your 529 plan originates.
How Does a 529 Work?
Think of a 529 college savings plan as you would a mutual fund savings plan. Funds are pooled together by multiple shareholders and invested in a variety of stocks, bonds, money market tools and other securities. Each state or educational institution manages their 529 plan investments differently. But ultimately, the idea is to provide a college savings strategy gleaning higher interest returns than a standard bank savings account earns.
Similar to a Roth IRA, the interest on a 529 plan grows tax free. Additionally, you may receive additional tax deductions on contributions made when investing in your home state’s 529 plan. However, that doesn’t mean you are limited only to the 529 plan offered where you live. You can enroll in a 529 plan from any state, regardless of where you live now, where you will reside in the future and where your child chooses to one day go to school.
When your baby is all grown up and ready to pursue college, you can withdraw funds from the 529 plan tax-free, so long as the money is used toward qualified costs—think tuition, room and board, books and supplies. If the money is used toward nonqualified costs, such as a car for your college student to commute between home and school or student season football tickets, a penalty of 10 percent is applied to the earnings on that withdrawal.
If you child grows up and decides not to go to college, all is not lost. The money saved can be transferred to a sibling, another family member or held for a future grandchild. Heck, you can use it to further your own higher education. And the 529 plan doesn’t just apply to traditional four-year universities. The funds from a 529 college savings plan can be applied toward the educational expenses of community colleges, vocational schools and other applicable post-secondary institutions. And if college just isn’t in the cards for anyone you know, take the 10 percent earnings penalty, along with income tax, and use it for whatever suits your personal needs.
529 Contribution Limits
Often tax-beneficial savings plans come with contribution limits, such as a Roth IRA at $5,500 or an employer-based 401(k) at $18,000. However, the 529 plan contribution limits are not so black and white. Technically speaking, the IRS does not have a set 529 plan contribution limit amount. But that doesn’t make it a savings free-for-all either.
Contributions to a 529 plan are essentially considered gifts in the eyes of the IRS. As of 2017, you can give away up to $14,000 as a gift annually per person (which includes the contribution made to a 529 plan), and the money will not be subject to gift-tax consequences. However, go over that amount and the excess will need to be reported when filing taxes.
The only other 529 contribution limit to consider is exceeding the max amount of qualified educational expenses. While it may be hard to predict how much your baby will need for school in 18 years, given the factors that affect those expenses, it’s better to err on the side of caution when saving to avoid the 10 percent earnings penalty.
529 Plan Rules
The 529 plan was created to be a flexible, easy-to-use savings tool when plotting for your child’s future. While there are applicable 529 plan rules, many are to the investor’s benefit.
- Beneficiary: There are no limitations for whom a 529 plan can benefit. Of course, parents use them to save for their child’s college education, but other beneficiaries can be grandchildren, relatives, friends or yourself.
- Income: No matter how much money you make, there are no income restrictions that apply to 529 plans.
- Quantity: Since a 529 plan is transferrable to other family members, friends or yourself, some parents choose only to set up one 529 plan, instead of one per child. With that said, you can open as many 529 plans as you like, as there is no limit, though you may be subject to maintenance fees depending on the 529 college fund you choose. Still, having more than one plan might make more investment sense, as you can adjust one 529 plan to more conservative risk levels for a child in high school nearing graduation, while being more aggressive with another 529 plan for a child still in elementary or middle school.
- Financial aid: When applying for financial aid, the amount of assistance received is based on a student’s assets as well as their parent’s assets. The money saved in a 529 plan is considered a parental asset, which means a student’s aid package could be reduced by up to 5.64 percent of the account value, according to SavingforCollege.com. Still, this is significantly less than other savings vehicle withdrawals, which are then counted as student income and assessed at up to 50 percent.
- Higher education: 529 plans are meant for educational expenses, but only apply to post-secondary education. Preschool, private school or prep school cannot be paid for using a 529 plan without incurring a penalty.
- Location: A majority of states each have their own 529 plan, some as a prepaid tuition plan and some as a college savings plan. While there may be incentives for investing in a plan within your home state, you can choose the best 529 plan available in the competitive market that is right for you.
- Timing: If money is tight when baby is born, saving for college may not be in the budget. The good news is there is no timing or age restrictions on when you start a 529 plan.
- Rollover: Don’t like the 529 plan you’ve selected to invest in? Don’t fret! You can rollover the money from one 529 plan to another without penalties or tax implications, barring any rules pertaining specifically to your 529 plan.
- You’re in charge: Just because your child may be the beneficiary of a 529 plan does not mean he or she can withdraw without your permission. Only the account owner has control of the funds during the life of the account. Additionally, the beneficiary does not have legal rights to this account in the event of your death, unless account ownership is designated to your child as your successor.
Starting a 529 Plan
If a 529 plan is the right investment strategy and savings tool for you child or other designated beneficiary, follow these steps for starting a 529 plan.
- Research: Just about every state offers a 529 plan, and each one is designed to be competitive in the market in order to attract your business. Additionally, each plan offers unique investment options. Your home state’s plans are a good place to start, as they may offer additional tax incentives on your contributions. But again, you are not limited to what is available in your state. Do your research and find out which 529 college savings plan is right for you, your budget, your investment strategy and your child’s future.
- Understand fees: There are a variety of different maintenance fees, enrollment fees and asset-management fees that may apply to the 529 plan you select. Before enrolling, be sure to understand what fees exist and how they may affect your investment. This information should be documented in official program disclosure statement (PDS). And while the PDS can be a bit cumbersome, be sure to read it in depth to best understand the 529 plan you’re considering.
- Name the account owner: Remember the 529 plan account owner is the person investing the money, while the beneficiary is the future college student. This allows you to maintain control over the money and make sure it is used as intended. However, most 529 plans do not allow joint ownership of an account. This may not be an issue between you and your spouse while married, but should you ever separate or divorce, it could become a legal issue. Consider having two separate accounts between marital spouses to avoid the mess.
- Select a successor: In the event of the death of the account owner, someone needs to be named as successor on the 529 plan application. This should be someone who is responsible and able to distribute the account funds as you had planned. You can also create a legal trust should you not feel comfortable designating the responsibility.
- Designate a beneficiary: To name a beneficiary to the 529 plan, you will need the child’s name, address, social security number and birth date. If the child is not yet born, designate yourself as the beneficiary and then update the 529 plan once the information needed is available. This can also be done should you want to transfer the beneficiary status from one sibling to another, for example.
- Contribute: Select a dollar amount to add to your 529 plan, making sure it follows any minimum dollar amount contributions specified. Your 529 college savings plan contribution may be based on your budget leeway, but also consider using a 529 plan calculator to base your contribution on the amount your child will need. If you want a foolproof way to save, consider setting up an automatic contribution from your checking or savings.
- Spread the word: If you’ve selected a 529 plan that accepts third-party contributions, be sure to let other family members know. Grandparents, extended family and close friends may like to gift funds to the account for birthdays and holidays, especially when the child is too little for toys and gifts they can actually enjoy.
Best 529 College Savings Plan
Which 529 plan is right for you will be based largely on your personal circumstances. That is, a 529 college fund that is right for you may not be right for your best friend. Still, when selecting a 529 plan, why not start with the best? Here are the 529 plans that pass with top honors:
Top 5 Plans
- The ScholarShare College Savings Plan (California): This California-state 529 plan historically receives high performance scores, has reasonable fees and offers sound investment options. This 529 plan specifically provides two age-based options, which allows you to be more aggressive with your investments while the beneficiary is younger and more conservative as he or she approaches college age. On the downside, if you are a resident of California, don’t expect state incentives, as this 529 plan doesn’t offer them up.
- Edvest (Wisconsin): Like California, the Wisconsin Edvest 529 plan offers two age-based investment options. Fees are lower than the national average and the investments have experienced steady growth similar to or just below California’s ScholarShare. Residents of the state of Wisconsin receive tax incentives for contributions to their home plan.
- NY’s 529 College Savings Program (New York): Managed by Vanguard and Upromise, New York’s 529 plan offers three age-based policy options: conservative, moderate and aggressive. Fees to open an account are very low at $25 and drop to $15 if contributing through payroll deduction. Maintenance fees are also low at $1.60 in fees per year for every $1,000 invested. There are no advisor or additional account maintenance fees or commissions.
- College Savings Iowa 529 Plan (Iowa): This Vanguard 529 plan boasts similar advantages to the 529 plans preceding it, including strong investment options and low fees. While its fees are a little higher at $2.00 in fees per year for every $1,000 invested, we like that it offers four age-based savings tracks in addition to 10 individual portfolios you can tailor to your risk tolerance and investment strategy.
- Minnesota College Savings Plan (Minnesota): Enjoy a variety of investments options with the Minnesota 529 plan, which is another strong performer. In addition to an all-in-one age-based option, this 529 college savings plan also allows you to invest in multi-fund option with more control, a guaranteed investment option with a stable return and lower risk, or a single-fund option with more risk for when you have more time to save.