Setting Up a 529 Plan: What You Need to Know

A 529 plan is a saving plan designed for future educational costs. We take a look at all you need to know about setting up a 529 plan

It’s projected that over 20 million students will attend college by 2027. College is expensive. If you think your children will attend a university, it’s crucial to save now. 

There are many ways to save for college tuition. A 529 plan is one of them. It’s designed specifically for future educational costs. Setting up a 529 plan doesn’t have to be hard. 

Read on for all you need to know about setting up a 529 plan. 

What’s a 529 Plan?

A 529 is a special savings and investment account. It’s for college tuition and other educational expenses. The money is also for some vocational and technical schools. Since 2018, expenses that qualify for the plan include K-12 tuition. 

The 529 is state sponsored. You don’t have to use the one offered by your state. It pays to compare the plans from different states. 

The advantage of a 529 plan is the rate of growth. Regular savings accounts aren’t always the best option. This is due to shrinking interest rates and potential inflation.

Another advantage to the 529 Savings Plan is taxes. The money saved in the account isn’t taxed at the federal level. And as long as you use the money for qualified expenses, it’s not taxed by the state when withdrawn. 

The money grows tax-free, though the money you put into the account isn’t deductible. 

The state where you get the account defines the qualified expenses.

Types of Plans

There are two types of plans:

  • Prepaid tuition plans
  • Education savings plans

With the prepaid tuition plan, you buy tuition credits from participating universities. These credits are for future tuition and fees at current costs. Prepaid plans can’t pay for room and board. 

Prepaid plans are also ineligible for elementary and secondary school tuition. The federal government doesn’t guarantee the prepaid plans either. 

The education savings plans are investment accounts for the beneficiary. The money is for tuition, fees, and also covers room and board. Up to $10,000 per year can be used for tuition at religious, public, or private elementary or secondary schools.

Setting Up a 529 Plan

Determine which plan works best for you. Most people buy their own state’s plan. You’ll usually get the most benefits that way. But if another state’s plan looks like it’ll be better for your beneficiary, you’re free to invest in it. 

If you have a financial adviser, discuss it with her. An advisor costs more, but it’s convenient to let someone else handle it.

Are you comfortable making your own investments? You can go with a low-cost direct-sold plan. If you do it yourself, you’ll save some money on fees.

Prepaid programs vary a lot from state to state. If you go with a prepaid plan, make sure you understand all the potential outcomes.

You’ll work with the state’s administrator to set up your account. Each state picks their own administrator, such as Vanguard. The administrator handles the accounts and runs the plan. 

Once you choose the state and plan, read all disclosure statements. Take time to read the fine print. The next step is naming an account owner. That’s going to be a parent or guardian.

Most 529 plans only allow one owner. 

Next, you’ll name the beneficiary. The beneficiary is the child receiving the money for qualified college expenses. The owner is the person controlling all assets within the 529 plan. 

It’s easy to link your checking or savings account to your 529 for automatic payments into the plan.

Limitations and Restrictions

State 529 plans must qualify under federal rules. The plans can’t take contributions above the anticipated costs of college expenses. The guidelines are broad. 

Because college costs have increased, most states allow contributions up to $300,000. Those limits go up over time since college costs keep rising.

It’s a good idea to keep your contributions under $15,000. This way you won’t get hit with the gift tax. 

One of the other nice things about the 529 plan is your ability to change the beneficiary. You’re not restricted. Did your oldest get a scholarship covering the cost of college? Change the beneficiary to a sibling. 

If you withdraw the money and don’t use it for qualified expenses, you’ll pay taxes at the federal and state level. You’ll also pay an extra 10% federal tax penalty on the earnings. 

If you don’t use the money for your beneficiary’s qualified expenses, most plans allow you to use the funds for your own education. 

Each state determines the investment options you’ll have available in the account. The investment options are pre-set. There are only two times per year that you’ll be permitted to change your investment option.

Financial Aid Eligibility

A 529 plan usually impacts student eligibility for need-based financial aid. But most students get financial aid through low-interest loans. Having money saved means you’ll borrow less. 

Mistakes to Avoid

Avoiding putting too little or too much money into a 529 account. Most states have low minimum contributions because many families can’t afford to save much for education. 

But don’t interpret the low minimum to mean you shouldn’t put much money in the account. Use a college calculator for determining how much you should save each month. 

You won’t know you’ve put too much in until you’re paying taxes, including a 10% penalty, on the excess money in the account. But, the tax is only on the capital gains. It’s not the worst thing to save too much. 

Most states don’t allow joint ownership of 529 accounts. No one wants to think they might end up divorced. But if you do, one parent ends up in control of the account. It’s not a bad idea to open two accounts and divide the contribution money into the two accounts, 

Your 529 Plan

Setting up a 529 plan is a good idea if you’re planning on sending one or more of your children to college. 

Decide which state’s plan you’ll use. Then figure out which type of plan you want. Name the plan owner and the beneficiary. Read the fine print so you understand any restrictions or limitations.

Have more questions? Contact us here