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Why You Should Consider a 529 Plan: Everything You Need to Know

Saving for college can feel like an uphill battle, especially if your child is still years away from completing their education. Competing tuition rates and costs, as well as the frequent changes to financial aid eligibility, make it challenging to save for your child’s future. However, there are many ways you can supplement their primary methods of saving for college. If you have a child who will be attending college in the near future or know someone who does, consider opening a 529 plan to help offset some of those expenses. A 529 savings plan is a type of investment account designed specifically to save money for future college expenses. Although these plans are not necessarily new, they have recently gained popularity among parents and grandparents looking for an easy way to fund their children’s or grandkids’ education without incurring significant taxes in the process.

What is a 529 Plan?

A 529 savings plan is an investment account designed to help you save money for future costs associated with your child’s or grandchild’s college tuition. Unlike other investment accounts, 529 plans allow you to withdraw the money you have saved at any time, without incurring significant taxes. This makes 529 plans an ideal source of income for parents who have children in high school or younger and need cash for college tuition immediately. Some states offer a 529 plan that allows you to contribute money toward your child’s future education at any state-run university or college. There are also some “flexible” 529 plans that allow you to withdraw the money you have saved to pay for any type of higher education expenses, including private or out-of-state colleges.

How Does a 529 Plan Work?

Similar to a Roth IRA, when you open a 529 savings plan, you contribute money toward college expenses for your child or grandchild. When your child goes to college, you will have saved enough money in your 529 plan to cover part or all of their tuition. At any time, you can withdraw money from your 529 plan to pay for any type of higher education expenses, including textbooks, rent, or any other fees associated with college. Depending on the type of 529 plan you choose, you will be taxed if you withdraw any money from the plan before your child goes to college.

Who Can Participate in a 529 Plan?

You can open a 529 savings plan to fund your child’s or grandchild’s future college tuition. You can even open one for a niece or nephew who shows an interest in pursuing higher education. Although most states allow anyone to open a 529 plan, some states offer a special incentive for residents to open a 529 plan. For example, New York, Massachusetts, and California allow residents who open a 529 plan to receive a tax break on their state income tax.

Advantages of a 529 Plan

Tax benefits – Tax-free growth, you will not be taxed for any contributions growing in a 529 plan. Additionally, if you withdraw money from a 529 plan to pay for your child’s education, you will not be taxed.
No minimum contribution – Most investment accounts require you to contribute a minimum amount of money each month to see any significant return. With a 529 plan, you can contribute as little, or as much, as you want each month.
Easy account management – As the account owner, you will have full control over your 529 savings plan. You will be able to see how much you have saved, as well as how much you need to contribute each month to meet your goal. Many 529 plans also offer online and mobile apps that allow you to monitor your account balance, make changes to your investment settings and withdraw money from your 529 plan.

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Limitations of a 529 Plan

Limited to one child – The money you have saved in a 529 plan can only be used toward the college tuition of one child. If you have multiple children who will be attending college, you will have to open multiple 529 accounts to cover all of their expenses.
One-time withdrawal – While you can withdraw money from your 529 plan at any time, you will be taxed on the amount you withdraw. If you need extra cash to pay for unexpected college expenses, consider borrowing money from a friend or family member, or taking out a student loan. You can always repay the loan after your child receives their tuition money.
No guarantee of college admission – Although a 529 plan will help you save money for your child’s future tuition, there is no guarantee that your child will be admitted to their top-choice university or if they even want to attend a college or university. Keep your fingers crossed, encourage your child to try their hardest in school, and look into scholarships and grants that can help offset any unmet costs.

Why You Might Not Want to Open a 529 Plan

There are many benefits associated with opening a 529 savings plan, but every investment account has its downsides. Before you open a 529 plan, you should consider all of the potential benefits and drawbacks associated with this type of account. You may want to consider a 529 savings plan if:

  • Your child is young and has plenty of time to save for college
  • You want to start saving now to prepare for your child’s future college tuition
  • You want to minimize your taxable income
  • You want to diversify your investment portfolio

You are concerned about your child’s future financial aid eligibility You may not want to open a 529 savings plan if:

  • Your child will be attending college soon
  • You want to save enough money to pay for your child’s entire tuition
  • You are concerned about the future of 529 plans

Conclusion

A 529 savings plan is an excellent way to save money for your child’s or grandchild’s future college tuition. These investment accounts allow you to contribute as much money as you want, whenever you want, without incurring significant taxes. There are many advantages to opening a 529 savings plan, including the fact that you can withdraw money from your account at any time without paying taxes. If you are concerned about the longevity of 529 plans, you can also consider opening a Coverdell ESA, which offers many of the same benefits of a 529 savings plan, but without the same level of government regulation.

Geisha Morris-Jacobs

Geisha Morris-Jacobs is an accountant with over 13 years of experience in accounting, taxes, and estate planning. She has helped dozens of clients with clearing up IRS audits and past tax debts. Geisha is also the owner of Jacobwise & Co., a boutique accounting firm that specializes in helping small businesses grow their revenue and individuals create estates to provide for their loved ones.

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