Your daughter just graduated college and is about to start her dream job. But there’s one problem: she still has student loans to pay off. She is not alone – the average graduate leaves school with over $28,800 in debt (Hanson, 2022). So how can you ensure your child does not end up in the same situation? One way is to start saving for your child’s education early on with a 529 plan.
- What is a 529 Plan?
- Savings Plans vs. Prepaid Plans
- Tax Benefits of a 529 Plan
What is a 529 Plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
What are the benefits of a 529 plan?
Some of the main benefits of 529 plans include:
- Federal and state (in some cases) tax breaks. Money invested in a 529 plan grows tax-deferred, and withdrawals are tax-free as long as they are used for qualified education expenses.
- Flexibility in how you save. With a 529 plan, you can set up automatic contributions from your bank account or payroll deductions, making it easy to save on a regular basis.
- Accounts can be used for K-12 education expenses as well as college.
- The account owner maintains control of the account.
What are the drawbacks of a 529 plan?
While 529 plans offer many benefits, there are also a few drawbacks you should understand.
- One potential drawback is that 529 plans have strict rules around how the money can be used. Withdrawals must be used for qualified education expenses, or they may be subject to taxes and penalties.
- Another potential drawback is that 529 plans are sponsored by state governments, which means that you may be limited to investing in the plan offered by your state of residence. However, many states offer residents the ability to invest in any state’s 529 plan.
Savings Plans vs. Prepaid Plans
There are two types of 529 plans: prepaid tuition plans and education savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a prepaid tuition plan.
The main difference between the two types of plans is that with a savings plan, the money is invested and allowed to grow tax-deferred. With a prepaid tuition plan, the account holder buys units or credits at participating colleges at today’s tuition rates. When the beneficiary attends college, the units or credits are redeemed for tuition and fees at that school.
Tax Benefits of a 529 Plan
529 plans offer several tax benefits that make them an attractive way to save for college. The earnings on the account are not subject to federal income tax; in most cases, they are not subject to state income tax either. This can result in substantial tax savings over time.
529 Plan account control and flexibility
One of the great things about 529 plans is that they offer account holders a high degree of control and flexibility. The account holder is the one who controls the account, regardless of who sets it up or who contributes to it. These benefits mean that the account holder can change the beneficiary at any time.
The account holder can also decide how and when the money in the account is used. For example, if the beneficiary earns a scholarship, the account holder can withdraw the money (up to the value of the scholarship) without penalty. The money can be used for other purposes, such as funding other retirement goals.
Conclusion
529 plans offer many benefits that make them an attractive way to save for college. They provide tax benefits, account flexibility, and control. If you are considering starting a 529 plan for your child’s education, research the options available to find the best fit for your family. If you have additional questions or need assistance, consider asking a Certified Financial Planning Professional.
References
Hanson, M. (2022, August 14). Average Student Loan Debt for a Bachelor’s Degree. Retrieved from Education Data Initiative: https://educationdata.org/average-debt-for-a-bachelors-degree
Author
Isaac is a Fee-Only (no products sold) Certified Financial Planner® Practitioner. Isaac founded Stalwart Financial Planning with offices in Fayetteville NC and Durham NC. Isaac provides comprehensive planning and investment management services to individuals from all walks of life. Isaac can be reached by phone at 910-867-8464, or by email (iallen@StalwartPlanning.com). Visit him at Stawart Financial Planning www.StalwartPlanning.com.