Giving It The College Try: 5 Things Every Family Should Know About 529 Plans
It seems like every day brings more bad news about rising college tuitions and mounting student loan debt. The average student loan debt for new college grads now exceeds $37,000, according to Cappex.com, a college and scholarship-information web site.
But there’s a more positive statistic worth mentioning too: total investments by American families in 529 plans reached a record $266.2 billion as of June 30, 2016, according to the College Savings Plans Network (CSPN), whose members include state treasurers and plan administrators.
That’s more than double the $104.9 billion in assets held in 529 accounts in 2008, at the beginning of the Great Recession. The average size of a 529 account has grown from $10,690 in 2008 to $20,975 as of mid-year 2016.
Created by Congress in 1996, 529 plans are tax-advantaged, college savings vehicles that can help parents and students accumulate tuition dollars and reduce their dependence on student loan debt.
Nearly every state, as well as the District of Columbia, offers at least one 529 plan. And you have the option to invest in your own state’s plan, or elsewhere.
“It’s never too late to start,” said CSPN vice chairman James DiUlio.
The ins and outs of 529 plans can sometimes seem as complicated as an organic chemistry course, but understanding their potential advantages and risks could be worth your time.
Here are five things you should know:
There Are Two Types Of 529 Plans: Prepaid Plans And Savings Plans
Prepaid tuition plans help families manage future tuition costs. With these types of 529 accounts, an account owner purchases a certain number of years of future tuition at today’s prices. While prepaid plans cover tuition, most don’t pay for other expenses, such as room and board. There are other restrictions as well.
Prepaid tuition plans have no investment options for you to choose from. Under prepaid plans, the price of the contract is determined prior to purchase and usually depends on the type of contract, the current grade of the beneficiary, the current and projected cost of tuition and the projected rate of return.
If your child chooses not to attend a college covered by the prepaid tuition plan, all is not lost. Although you will not get the benefit of guaranteed tuition, all prepaid tuition plans allow you to use plan money to pay tuition at other colleges and universities.
Currently, there are 13 prepaid plans, 12 offered by states and one offered by a group of private colleges. Some states guarantee that they will be able to fund future tuition and others do not. Before committing your dollars, it’s important to determine what types of guarantees a prepaid plan might have.
With a 529 savings plan, you pay money into an investment account on behalf of a designated beneficiary. Generally, plans will allow you to choose among multiple types of investments, including mutual funds and exchange-traded funds. Your investments could go up or down in value, depending on how the market performs.
One popular investment option within 529 plans is an age-based portfolio. Much like target-date funds offered by 401(k) plans, these investments start out more aggressive when the beneficiary is young and automatically become more conservative as he or she nears college-age.
There Can Be Meaningful Tax Savings
529 plans are named after a section of the tax code—and they offer some A+tax advantages.
Contributions to a 529 savings account are made with after-tax dollars, but earnings grow tax-free. Withdrawals from a 529 account aren’t taxed so long as the money is used for qualified higher education expenses, such as tuition, housing and textbooks. And there are no income limitations to contributing to a 529 plan.
On top of that, many states offer a state income tax deduction or tax credit for all or part of a taxpayer’s contributions to that state’s 529 plan.
“Check your own state’s plan first,” DiUlio said.
Another potential advantage: the IRS generally allows taxpayers to give no more than $14,000 a year to another person without triggering a federal gift tax. An exception is a 529 “gift.” An individual can contribute up to $70,000 in one year to a 529 plan.
Understand The Impact 529 Plans Have On Financial Aid Eligibility
“Expected Family Contribution” (EFC) is a number used by a school to determine how much financial aid a student is eligible to receive. The higher the EFC, the less aid a student might get.
The good news is that when calculating EFC, only a small portion—5.64 percent—of 529 plan assets are considered. In contrast, other college savings vehicles, such as custodial accounts, can see a much higher amount—even as high as 20 percent—of the value of the asset considered in determining EFC.
Likewise, distributions from a 529 account are treated favorably. Qualified distributions from a 529 account owned by a student or a parent are excluded when calculating the income that also goes into financial aid eligibility calculations.
Be Aware Of Fees
All 529 college savings plans have fees and expenses. Not only do these charges vary among 529 plans, they can vary within a single plan, as well. Higher fees and expenses can make a difference in the value of your investment over time.
Let's say you invest $10,000 in a college savings plan with a return of 8 percent before expenses. With a plan that had annual administration and operating expenses of 2 percent, after 18 years, you would end up with $27,880. If the college savings plan had expenses of only 0.65 percent, you would end up with $35,548, an additional $7,668.
You can use FINRA’s 529 expense analyzer to compare 529 fees and expenses.
In some cases, you might find that the tax break offered by your state isn’t enough to compensate for a plan’s high fees.
529 plans can be purchased directly, or through a broker. If you're comfortable going it alone, you can often save money investing in a direct-sold plan.
“Minimizing expenses is key to maximizing net returns,” said Cappex publisher Mark Kantrowitz.
Do Your Homework And Shop Around
Saving for college isn’t easy and you have a lot of options. In addition to 529 accounts, there are Education Saving Accounts, custodial accounts and savings bonds. You can learn about these other college savings options in FINRA's Smart Saving for College learning center.
Whichever way you choose to save for college, it’s important to understand what you’re investing in, the tax implications, and the costs and fees involved. Remember, every dollar you save for college is one less dollar you’ll have to borrow.