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For many families, saving for college is almost as much a given as saving for retirement. According to a Sallie Mae study, “How America Saves for College,” 51 percent of families are putting money aside for college this year, compared with 55 percent who will save for retirement.
Both those numbers are surprisingly low, in my opinion, but not nearly as shocking as the number of people who have no clue about the best way to save for college.
A survey conducted by investment firm Edward Jones found that 70 percent of Americans couldn’t tell you what a 529 plan is. (Hint: It’s a college savings plan.)
It makes you wonder where those 51 percent of families are putting their money if so many are in the dark about 529 plans.
If you’re part of that 70 percent and college may someday be in your family’s future, keep reading. Abby Harper, a spokeswoman for Upromise by Sallie Mae, has offered to help us sort out some of the basics about these college savings plans.
What is a 529 plan?
Let’s start with the basic question. We’ve already established that it’s a college savings plan, but what exactly does that mean?
I’ll let Harper explain:
A 529 plan is a unique savings vehicle – typically state-sponsored – designed to help you save for a loved one’s college education. The individual who sets up the account – usually a parent or grandparent – is considered the account’s owner, and the owner names the beneficiary of the account. [The beneficiary is] usually a child or grandchild, although the account owner may even name him[self] or herself as the beneficiary of the account if saving for his or her own education.
Once the 529 account is set up, owners generally have the option of selecting from a variety of portfolios or funds to invest money in.
“They range from fixed-income portfolios to equity-based portfolios to age-based tracks that are designed to become more conservative as a beneficiary gets closer to college,” Harper said.
You may want to invest the money more aggressively if your child is an infant or toddler than you would if they are in high school. For more on that, you can read Money Talks News finance expert Stacy Johnson’s advice on 529 investing.
What are the benefits of a 529 plan?
There are a number of reasons to use a 529 plan for college savings:
- Earnings used for education are tax-exempt. “With a 529, your money grows free from federal and state taxes, and your earnings are never taxed as long as it is used to pay for qualified higher education expenses,” Harper said.
- States may deduct or credit contributions. Depending on your state, you may be able to deduct your contributions from your state income taxes. Other states may offer a tax credit. For example, Harper says Indiana offers a state tax credit of 20 percent on contributions up to $5,000.
- Higher contribution limits. Speaking of contributions, you can put way more money in a 529 than you can in a Coverdell Education Savings Account, the other main tax-advantaged vehicle for college savings. With a Coverdell account, you can contribute only $2,000 per year per beneficiary. The 529 plan limits may vary by state, but most let you sock away up to a total of $200,000 per beneficiary, assuming your pockets are that deep. However, to avoid a gift tax, you need to keep your annual contribution less than $14,000.
- Ability to change beneficiaries. If one of your children washes out, you can always change the beneficiary to another child or family member.
What happens if my child doesn’t need all of the money?
Wouldn’t that be a great problem to have!
Seriously, if your child gets a scholarship or graduates, and there is still cash in the account, you can simply change beneficiaries. There are no tax penalties for switching to another family member. Harper says that includes any of the following relatives:
Or maybe you could make yourself the beneficiary and go back to school for your own degree.
Now, let’s say you don’t have any other relatives who can use the cash. In that case, you can pull the money out — but be prepared to pay some taxes and penalties.
“If you withdraw from your 529 for non-education-related expenses, your earnings are subject to federal income tax and a 10 percent federal penalty as well as state and local income taxes,” says Harper. “However, the 10 percent penalty may be waived if the beneficiary dies, becomes disabled or receives a scholarship.”
What else do I need to know?
Finally, you need to be aware that 529 plans are just like your IRA and 401(k): They aren’t a sure thing.
“As with any investment, if the portfolio you invest in loses value, then the account value will suffer,” Harper said. “Make sure to plan appropriately and consider whether or not a 529 is the best option for you and your savings timeline.”
Further reading on 529 plans
While you’re reading about 529 plans, you may also want to head to the IRS website for its FAQs on the subject. Not quite as fun reading as what you find here on MTN, but sometimes it’s good to hear straight from the horse’s mouth.
Incidentally, if you haven’t already checked out Upromise, it has a nifty little program in which you earn cash rebates for your everyday purchases. The rebates can be deposited in a savings account or 529 plan, used to pay down Sallie Mae student loans, or cashed out in the form of a check.
And there you have it! Now, you can proudly say you are one of the 30 percent who knows what a 529 plan is and why you might want one.