What is a 529 College Fund?

A 529 college fund is a tax-favored savings plan designed to assist you with paying for educational expenses. Initially only available for postsecondary tuition and apprenticeship programs, these accounts are now accessible for K-12 tuition and other educational costs as well.

These funds grow tax-deferred and can be withdrawn tax-free for qualified higher education expenses such as tuition, fees, books, computers, room and board. Furthermore, beneficiaries may use them to cover student loan payments.

Tax-deferred growth

A 529 college fund allows savers to grow their money tax-deferred. Withdrawals from the account can be tax-exempt if used for qualified education expenses like tuition, books and room and board.

Given the current crisis of college costs, it’s essential to start saving money early for future educational endeavors. The earlier you start saving, the longer it has to grow and compound tax-deferred.

To get started, select a plan that invests in stocks and bonds, then set up automatic contributions. There are various options to consider, such as direct-sold plans or those managed by retail firms. Many offer low fees and broad-based investments.

Your investments will depend on your risk tolerance and the plan’s asset allocation menu. Most age-based portfolios start out with stocks for early years, then transition into bonds as your child approaches college age.

Another option is a “prepaid tuition” plan, which guarantees today’s college tuition rates for eligible public and private colleges. These can be an ideal solution for families who cannot afford much contribution towards traditional 529 plans or who are saving for more than one child’s education.

If you don’t want to manage your own investments, there are many advisor-managed 529 plans available. These typically offer pre-set portfolios with stocks and bonds but may come with additional fees or commissions.

Finally, there are investment-only options such as Vanguard 529 College Savings Program which invests in index mutual funds. This option may be particularly appealing for individuals without much investing experience.

The plan’s investment options are relatively flexible, allowing you to adjust them as your child’s needs evolve. If unsure which investment options are suitable for you, consult an adviser who can suggest a tailored strategy tailored to your situation.

Though the IRS is considering eliminating some tax breaks associated with 529 plans, these savings vehicles remain an integral part of financial planning. Unfortunately, they remain poorly understood by most consumers and their use continues to decline.

Tax-free withdrawals

A 529 college fund offers tax-exempt savings for education expenses. The money in the account can compound and grow tax-free over time, potentially providing substantial increases over time. What’s more, these funds may be withdrawn without penalty if used for qualified educational expenses.

Qualified education expenses include tuition, required fees, books, supplies and computer equipment for a student who is enrolled at least half-time. Some of these costs may also be covered through grants, scholarships and other tax-exempt assistance programs.

To determine how much your child can withdraw, add up all eligible expenses (tuition, fees, room and board) and subtract any grants, scholarships or other tax-free assistance such as Veteran’s benefits or Pell Grants. The result is known as your child’s adjusted qualified higher education expenses (QHEEs).

You cannot withdraw more than your child’s QHEE balance. However, any remaining balance can be used to pay off qualified student loans; under the SECURE Act you are allowed to use up to $10,000 from each beneficiary and their siblings for this purpose.

Even if your child doesn’t end up attending school, the money in your 529 account is still accessible for other needs. You can use it to cover emergency payments, increase retirement savings, finance home renovations or any number of other necessities.

Nonqualified withdrawals that earn income are taxed as taxable income and could incur an additional 10% penalty if your child’s 529 account is located outside your state, or funds are taken out for nonqualified expenses such as an emergency medical bill. This penalty could be higher if there’s no state income tax in your home state and the funds come from a different 529 account that does have one, or if there are funds in the account to cover nonqualified expenses such as emergency medical costs.

There’s one exception to the 10% penalty: if your child receives a scholarship. With such an award, any withdrawals made are considered qualified expenses and you won’t need to pay a 10% tax on earnings.

It is essential to make the 529 withdrawal before your child turns 18 or graduates from high school, whichever comes first. Otherwise, the withdrawal will count as a “qualified distribution” for federal tax purposes and be subject to taxes and penalties.

Eligibility

A 529 college fund is a type of savings account open to everyone that can be opened. These funds can be used for covering an array of educational costs such as tuition and fees, books and supplies, approved study equipment and room and board at accredited colleges or universities.

Contributing to a 529 plan allows your money to be invested tax-deferred until it’s withdrawn for qualified education expenses. This allows parents and grandparents to save more for their child’s college education than if the same amount were saved in a taxable account, where earnings are subject to federal income taxes.

Funds invested in tax-deferred accounts can grow tax-deferred until they’re withdrawn – which may or may not be free depending on your state and investment choices. However, if any of the moneys are used for nonqualified educational expenses, you may owe federal and state income taxes on earnings plus an additional 10% penalty tax.

You can use the money in a 529 plan to cover K-12 tuition (up to $10,000 annually), apprenticeship programs and student loan repayments. This is an effective way of saving for higher education expenses even when you’re already employed and have other debt obligations.

As a parent, your savings in a 529 plan may affect your child’s eligibility for financial aid. For instance, if you save more than the allocated $10,000 allowance for need-based assistance purposes, that person’s eligibility will be reduced.

Conversely, if your child’s 529 plan is owned by a grandparent or other third party, those assets won’t count towards financial aid calculations. However, distributions from this 529 can affect eligibility for financial assistance, so be wary.

Lisa Biar, founder and president of Investing For Kids, recommends delaying withdrawals from your grandparent’s 529 until your child’s senior year in college. Doing this prevents the funds from counting as taxable income on the Free Application for Federal Student Aid and could reduce need-based aid eligibility.

Flexibility

A 529 plan is an ideal way to save for your child’s college education. It offers several advantages, such as high lifetime contribution limits and tax-deferred growth on contributions used for qualified education expenses. Furthermore, this type of savings vehicle offers plenty of flexibility.

One of the key advantages for parents is having more control over their investments than most other accounts. They can make changes twice annually, direct withdrawals, and change beneficiaries at any time – giving them flexibility to pause college for a gap year, defer admissions to another school, or simply change their mind about where their kids should attend college.

Other 529 features include prepaid tuition plans that enable parents to prepay their children’s college costs in advance, helping keep down budgets. These plans are available across all 50 states and could be an ideal solution for parents whose child plans to attend an in-state public or private school.

Another attractive benefit of a 529 plan is its flexibility; it can cover tuition and fees at many colleges, trade schools, vocational schools and other educational establishments – whether public, private or nonprofit. Most of these schools qualify for federal financial aid programs as well.

These include public and private universities, community colleges, technical colleges, career colleges and apprenticeship programs. Funding can even be allocated for tutoring services, supplemental learning materials and special needs services.

Additionally, some 529 plans can be used to cover K-12 public and private school tuition and fees. Not only that, but a 529 plan may also cover books, supplies, room and board expenses, computers with internet access and equipment necessary for a student’s course of study.

Saving for your child’s college education can seem like a daunting financial goal, but it is achievable with some careful planning and discipline. Beginning early and saving regularly are essential ingredients in taking advantage of tax benefits offered by 529 plans.

For instance, the SECURE 2.0 Act passed Congress last December and allows 529 funds to be tax-exempt rolled over into Roth IRAs tax-free. This provision will take effect in 2024 and could provide families with leftover funds from their children’s education that need tax-free investment opportunities.