Saving for Your Education: Understanding a 529 Plan
Education is a right deserved by all citizens. But as foundational as education may be, it might not be accessible at all levels for everyone, especially for higher education. While you may be familiar with student loans, grants, and scholarships, there are other paths you can seek to save for your goals. One of these options is an educational savings account, commonly known as a 529 Plan.
What is a 529 Plan?
A 529 Plan is a tax-advantaged investment account. The funds in a 529 Plan are for covering educational expenses, such as kindergarten through 12th grade education costs, postsecondary education and apprenticeship programs, and student loan repayment. The tax advantages of a 529 Plan mean the funds earn tax-deferred growth and any withdrawals made are tax-free so long as they are for specified educational purposes.
The scope of 529 Plans expanded significantly within the past ten years beyond covering college and other forms of higher education. Congress passed legislation allowing the funds to be used for kindergarten through 12th grade schooling, as well as apprenticeship programs for trades and other areas and student loan repayment. The name of the account itself comes from Section 529 of the Internal Revenue Code.
Types of 529 Plans
There are two types of 529 Plans: college savings plans and prepaid tuition plans.
College Savings Plan
A college savings plan is just like it sounds and is used for schooling costs. When the account is opened, the holder can begin to place funds into the account which are then applied to investment options selected by the holder. Of the 529 Plan options, college savings plans are more common, and the performance of the investments will determine how much the plan earns over time.
The money in a college savings plan can be used for college or kindergarten through 12th grade expenses, including tuition, room and board, books, or even traveling abroad in some instances. As the plan matures, the investments may become less risky as the target date approaches. In other words, your plan administrator will encourage you to be less risky with the funds the closer the time comes to them being needed.
Prepaid Tuition Plan
With a prepaid tuition plan, the account holder can lock into a current tuition rate for a student who will attend higher education in the future. This type of plan could be an excellent option for those looking to combat rising higher education costs. According to OnlineU, in-state rates for public universities have increased by 7% over the last five years, while out-of-state rates (which already typically cost more than in-state) have increased by 5% in that same timeframe.
Like rising education costs, prepaid tuition plans and your ability to access them vary from state to state. Funds from this type of plan can also only be used for higher education, as opposed to elementary or secondary education. You also may be limited in the types of colleges you can use these funds for. Be sure to explore all your options with a prepaid tuition plan with your account administrator before enrolling in the plan.
How Does a 529 Plan Work?
A 529 Plan operates by allowing the account holder to invest their funds in assets like mutual funds or bonds. Parents and grandparents are typically the ones who will open these plans. The beneficiary is who will ultimately benefit from these funds, and is generally a child, grandchild, or other relative who intends to attend college or another form of higher education.
You can work with your financial institution where you hold the plan to explore investment options. They will also be able to tell you about the benefits of the plan, since it is a tax advantaged account. Tax-free withdrawals for relevant education expenses are limited to $10,000 each year.
529 Plans & Penalties
Like certificates and IRAs, 529 Plans do carry penalties. The specifics of each penalty vary by state, but most come into play when withdrawals are made for non-education related expenses. According to Saving for College, a 10% withdrawal penalty is applied on the earnings portion of a 529 Plan. Your contributions will not be subject to a penalty, since they are made with post-tax funds.
There are some exceptions for 529 penalties when it comes to tragic or unfortunate circumstances. If the beneficiary opts to not attend college or another form of higher education, or if they unfortunately pass, the plan is transferable. The plan can be transferred to another family member in this instance without consequence. Family members can include another sibling, a niece or nephew, or a grandchild.
In the event of a change of plans, you may need to roll over the funds from one 529 Plan into another. Rolling over means to take the funds in one plan for one family member and move it into another. A rollover can be tax-free so long as it’s completed within 60 days from withdrawing the funds.
529 Plans vs. Student Loans
Student loans are an incredibly common form of payment for higher education. A 529 Plan is different from a student loan in that the funds in a 529 Plan are those of the account holder, combined with the earnings made through the plan’s investments. With a student loan, the funds are borrowed from a lender and are required to be paid back based on the loan’s terms.
A 529 Plan can be useful when paying back your student loans as well. The SECURE Act of 2019 allows for funds in 529 Plans to be used to repay student loans up to $10,000. This loan would need be the beneficiary’s student loan, and not the account holder’s.
529 Plans & American Heritage
You can explore 529 Plans and other savings options with American Heritage’s Investment & Retirement Center (IRC).* Our IRC representatives can go over your options and help you strategize to meet you and your family’s financial goals. Learn more about American Heritage’s IRC here.
No matter your plans, you have lots of options when it comes to saving for education! A 529 Plan presents a unique opportunity to both reach your savings goals and earn tax advantages along the way.
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