The average cost of tuition for a 4-year college is $125,000. For a private university, the cost jumps up an additional nearly $75,000. I can throw more 6-digit numbers out there, but I’m assuming that’s enough to convince you to start saving money for college if you haven’t already.
So yea, college is expensive. But did you know there is a savings account dedicated to putting money away for college tuition and expenses? While stating “college is expensive” isn’t breaking news, saving money in your own college focused savings account isn’t on everyone’s radar.
Why? States across the US wondered the same thing.
To motivate individuals to save money for their descendant’s college tuition, States created legislation that allowed for qualified tuition plans. These qualified tuition plans are better known as 529 College Savings Plans.
When you invest money in stocks and net a positive return, that money is taxed as income (the more you make, the higher the percentage in which it’s taxed). A 529 Savings Plan allows you to invest money in stocks and not get taxed on those earnings. The kicker is that the money in a 529 Savings Plan is limited in how it can be spent.
How can you spend the funds and why would a qualified tuition plan possibly make sense for you?
Here’s what you need to know about a 529 College Savings Plan … in 5 minutes.
Saving for college using a 529 Savings Plan
The good news is that a 529 Savings Plan allows you tax-free growth. The drawback is the money that accumulates in the fund must be spent on college or some educational expenses for a single beneficiary (your child for example).
That said, unless you’re planning on never having a child and or/are indifferent in having said child obtain an education, there’s likely little reason to not consider a 529 Savings Plan.
A lack of disposable income or recovering from debt can put saving for a beneficiary’s college on hold. But even if you have little means to save money, sill contributing an amount as small as $20 a month could be worth as much as $23,000 (with 6% expected return on investment) over 18 years. In-state tuition and room and board averages $21,000 for a year. So even the smallest investment in a 529 savings plan could pay off a year of college in the long run.
Is a 529 savings free?
Anyone can start a 529 Savings Plan through their own state free of cost. There are a certain set of nominal fees, the lowest (according to Scholar Raise) is New York state which includes a paltry .13% management fee.
Why pay anything at all for a savings account?
A 529 Savings Plan is more than just a piggy bank, it’s money being put to work. If you invested in a savings account with most banks, you’d be lucky to get anything greater than .1% on your return. A 529 Savings Plan allows a broker to manage and invest your funds to generate gains tax-free.
How to start a 529 savings plan
Starting a 529 savings plan involves a couple of immediate steps:
- Choose a beneficiary for your 529 Plan
- Open and deposit money into your account
- Choose age-based funds and start investing
These are funds that adjust your portfolio depending on how close/far your beneficiary is from attending school.
Starting a 529 plan on your own
As is the case with setting up any form of trust, it’s ideal to have some assistance or to outright let someone else start and manage your fund. The aforementioned scholar raise specializes in this.
As previously mentioned, anyone can start a 529 College Plan. The main question is: who are you saving money for? Spoiler alert: your 529 Savings Plan can’t just go to anyone. According to the Internal Revenue Service, the funds must go to an assigned beneficiary:
- Step-children, foster children, or adopted children
- Nieces and nephews
- Aunts and Uncles
- First Cousins
- Godchildren are not a specific beneficiary.
529 contribution limits
A 529 does have a max contribution limit, which varies by State. Mississippi and Georgia have the lowest contribution limits at $235,000, meaning that is the most you can contribute for a single beneficiary a.k.a. a single account. New York and Pennsylvania offer two of the highest limits at $520,000 and $511,758 respectively.
As far as a limit for a given year, the SEC does caution that any contributions totaling over $15,000 for a given year can be deemed as a gift and is subject to taxation.
For all of these cases however, multiple 529 plans can be created for different beneficiaries. This allows the account holder to “raise” their limits and to spread out the savings across different beneficiaries if you’re the kind of person who has the cash.
What expenses qualify for a 529 plan
A 529 savings plan is primarily engineered to save money for college, but what exactly does that mean? These are the eligible expenses you can spend a 529 savings plan on:
- College tuition
- K-12 tuition (up to 10k per year)
- College books and supplies (printers, computer, software, and wifi)
- Room and board (not transportation)
- Student loans
Can you withdraw money not for college?
Technically yes, but with a 10% fee, in addition to the income tax on whatever you withdraw. So for instance, if you make $50,000 a year and withdraw $5,000 from your 529 Savings Plan, you’ll be taxed at an income level of $55,000 and be penalized with a $500 fee.
Do 529 savings plans affect financial aid?
Yes and no. The SEC says it’s likely that having a 529 college savings account will affect financial aid eligibility.
To fully answer this, understand that most financial aid determinations are based largely on what’s called your Estimated Family Contribution, or EFC.
If you are a dependent, meaning it’s assumed your family will pay for your college and is the owner of the 529, 5.5% of the 529 assets will be calculated towards the EFC.
If you are not a dependent and it’s assumed you are paying for your own college, you own the assets of the 529 and thusly 20% of the plan assets will count towards your EFC.
Overall, the potential impact on how much financial aid you can receive shouldn’t be a determining factor in starting a 529 savings plan. Most financial aid is dispersed as a loan at 2.5%-5% interest rate that you will need to pay back in the long run. Starting a 529 Savings Plan gives your beneficiary a head start to begin paying it off.
Saving money is not a fun thing to do. It’s safe to say that spending money is much sexier than watching your money grow at 6% a year. But the point of saving money isn’t to have fun, it’s to do what’s needed. Carving out a portion for a 529 is one of the most advisable, long term saving options one can start, allowing you to earn money tax free while investing in the future of a loved one’s education.