How 529 Plans Can Help With College Tuition

If you think diapers are expensive, wait until you receive that first college bill. The average cost of in-state tuition at a public, four-year institution now approaches $12,000 for an academic year. Add in fees, books, supplies and room/board, and you’re looking at over $100,000 for your child’s undergraduate degree. Triple that number if your offspring attends a private school. While some students shoulder that financial obligation on their own, most families use a variety of funding sources (parent income and savings, scholarships, grants and loans) to cover the costs. Although there’s no one way to save for college, 529 plans can be a useful tool.

What is a 529 plan?

“Qualified tuition programs” (or “529 plans”) were first created by Congress in 1996. Named after section 529 of the Internal Revenue Code, they’re flexible, tax-advantaged savings plans designed to encourage saving for future education costs (like college, trade school, vocational school and even K-12). The plans are sponsored by a state, state agency or educational institution.

There are two basic types of 529 plans. Education savings plans are the most common (and what we’ll focus on). Most are available to everyone, although a few have residency requirements. Prepaid tuition plans, which typically have residency requirements, are the second type.

“For many families, the 529s offer a great balance of high savings potential, investment flexibility and a broad range of qualified uses,” says Philip Mock, Certified Financial Planner and founder at Tulsa’s Cathedral Square Capital.

Although 529 plans are a good way to save, Mock notes they’re not the only option.

“There are also Coverdell Education Savings Accounts, the new Trump accounts, geared more towards a head-start on retirement but could be used for education, and old-fashioned taxable savings to consider as well,” Mock says. “Of course, what makes sense for any specific family is unique to their specific circumstances.”

How do they work?

Anyone can open a 529 account, including parents, grandparents and other relatives. The person who opens the 529 plan account is called the account holder. The person the account is opened for is called the designated beneficiary or the student. The account holder and the beneficiary can be the same person.

Money contributed to a 529 account can be invested (mutual funds, ETFs, etc.) to allow for potential growth over time. The investment grows tax-free, and qualified withdrawals (for expenses like tuition, books and supplies) are also tax-free. You can contribute up to $19,000 per year ($38,000 for couples), per student, without triggering federal gift taxes. Depending on where you live, you may also be eligible to deduct part of your 529 account contributions from your state income taxes.

It’s important to remember that setting up a 529 plan is an investment decision, so it’s imperative to consider the benefits and drawbacks, as well as alternative ways of accomplishing the same thing.

When should I start?

There is no time like the present when it comes to saving for education.

“As the saying goes, ‘The best time to plant a tree was 20 years ago; the second-best time is now,’” says Mock. “The sooner the contributions are made, the more time they have to grow and compound. The tax-deferred growth, which becomes tax-free if used for qualifying expenses, in a 529 plan is one of the best benefits. And, as it relates to compounding, there is no greater friend than time. Plus, many states offer a current state income tax deduction or credit for contributions.”

Things to consider about 529 Plans

While 529 plans are an excellent tool, they aren’t for everyone, and it’s important to understand the regulations and the differences between individual plans, as well as the advantages and disadvantages associated with using them as a savings vehicle.

Some of the “cons” include limits on how the funds can be used and penalties for non-qualified withdrawals (funds used for non-educational expenses). In addition, the account owner, not the beneficiary, controls the funds, which can be an issue in cases like divorce. Some plans charge fees, and investment choices may be limited.

“The greatest con of a 529 plan is that it is by far best used for educational needs. If those needs don’t present themselves due to a change in college plans or college costs, due to scholarships, for example, leftover funds that cannot be transferred to another family member may seem ‘stuck,’” says Mock. “While unexpected funding from scholarships does get some relief in the tax code, it is still a consideration. Funds used for non-qualifying expenses are taxed on the earnings plus potential penalties. Contributions are generally returned tax-free. Alternatives for this situation include: partially rolling funds to a Roth IRA under recent tax law changes, holding the funds for future grandchildren or other educational future needs like graduate school.”

One of the biggest benefits of 529 plans is that earnings grow tax-free and withdrawals for qualified expenses aren’t taxed. The tax deductions and credits offered by many states further sweeten the pot.

“Aside from the compounding, 529 Plans have grown in flexibility over the years. They now cover a broader range of collegiate expenses and can also be used to cover K-12 school tuition costs as well — up to $20,000 annually per student, though some states have their own unique limits,” says Mock. “They also are flexible with regard to being able to transfer balances between other family members, such as siblings or cousins, in order to help balance the likely imbalanced college costs among children. They also can be used for non-college expenses such as trade schools, non-degree training programs and obtaining recognized credentials.”

Learn more about 529 Plans

Although there’s no universal “best way” to save for college, 529 plans can be a good option, depending on your individual needs and financial situation. To find out more about Oklahoma’s 529 plans, visit oklahoma529.com, or contact your financial advisor or tax professional.

Julie Wenger Watson is a freelance writer who’s worked in all aspects of music promotion. She’s also Co-Director of “Live From Cain’s,” a public radio show pilot.