While it’s hard to say what will happen to the costs of higher education over the next decade, it seems pretty clear many families are on their own when it comes to financing college for their children. And unfortunately, this reality applies to everyone — not just people who don’t qualify for any financial aid.
The fact is, even if you do qualify for financial aid, it’s usually not enough to cover the costs of higher education and everything else you have to pay for to earn a degree. The numbers don’t lie.
According to recent National Center for Education Statistics (NECS) data, 87% of students qualified for financial aid for the 2019-2020 school year. In the meantime, average student debt per borrower at graduation had still climbed to $30,600 as of earlier this year, and Americans with student debt now owe a collective $1.75 trillion dollars across both federal and private student loans.
But, what should everyone be doing to plan ahead for college? While individual circumstances can impact the best course of action for individuals, 529 college savings plans are still the best way for most people to pay for college.
Since today is “529 Day”, it seems like a good day to go over the benefits of these plans and who can qualify. Should you open a 529 plan if you want to save for future education expenses? Probably. Read on to learn all the reasons you should at least consider it.
What Is A 529 College Savings Plan?
At its core, a 529 plan is an investment account that lets families save for eligible education expenses on a tax-advantaged basis. That said, the way funds in a 529 plan can be used has been broadened over the years, and families can now utilize these accounts to cover the costs of higher education, K-12 tuition for dependents (subject to annual limits and state rules), apprenticeship programs and even student loan payments (subject to lifetime limits and state rules).
Notable details about 529 plans:
- Tax Advantages: 529 plans can accrue interest or grow in value without any taxes due on earnings.
- Tax-Free Withdrawals (potentially): When the funds are withdrawn to cover eligible education expenses (or other eligible costs), withdrawals are tax-free.
- State-Based Incentives: Two-thirds of states offer tax advantages for contributing to a 529 plan, which may include deductions or credits. Find your state here and see if you qualify for 529 plan tax breaks.
- Widely Available: Because 529 plans do not have any income restrictions, they can be utilized by nearly anyone.
- Investment Options: Your investment options may be limited by the 529 plan and program you use, but funds can usually be invested into target date funds, stocks, mutual funds, and more.
- Flexibility: You can use a 529 plan to save for anyone’s higher education expenses, including your child’s, another family member’s, or your own.
- No Rules On Who Can Contribute: It’s actually rather common for other family members to contribute to a child’s 529 plan outside of their parents, including grandparents and aunts and uncles.
From here, 529 plans do get somewhat tricky. This is partly because 529 plans are state-sponsored, so there are a wide selection of available plans with terms that vary dramatically based on where they are based.
Financial advisor Danny Cieniewicz of Hyperion Financial points out that one commonality they all hold is that they grow income-tax deferred and withdrawals for eligible expenses are tax-free, but that some states take the benefits up a notch.
“For certain states, if you make contributions to a qualifying plan, you can also receive a state-income tax deduction, making it one of the few financial instruments that can get a triple-tax savings,” said Danny Cieniewicz.
One of the best examples of this is the state of Indiana where individuals get a 20% tax credit on the first $7,500 they contribute to a 529 plan each year, or up to $1,500 back from the state when they file their taxes. Considering this benefit is not limited by income in any way, it’s a huge benefit. And as a result of this tax benefit, Indiana is one of the best performing 529 plans.
And if you’re worried about over-saving for college, you may not need to. Cieniewicz points to a provision in the recently-passed SECURE Act 2.0 that allows funds from qualifying 529 plans to be “rolled over” into a Roth IRA as well. In this scenario, families (starting in 2024) can roll over up to $35,000 from a 529 plan to a Roth IRA for the dependent, subject to annual contribution limits.
So, if you should happen to set aside more college funds than you need, you could use it to give your dependent a boost toward their retirement.
What Can 529 Funds Be Used For?
We already mentioned how you can roll over unused 529 plan money to a Roth IRA (terms apply), as well as the fact funds can be used to cover K-12 tuition or student loan bills. When it comes to covering K-12 tuition, a limit of $10,000 per student (per year) applies to those attending public, private, and parochial schools. Meanwhile, a $10,000 lifetime limit per borrower applies when it comes to using 529 college savings funds to repay student debt.
But, 529 plans were created to cover the costs of higher education. Here’s a rundown of the ways families can use the money they have saved, plus earnings they accrue:
- Tuition and fees
- Books and supplies for school
- Computers, software and internet access for school
- Room and board at college only
- Special needs equipment required for college
Also be aware that 529 funds can be used to pay these eligible expenses at a broad range of institutions. This includes traditional colleges and universities, community colleges, vocational schools and trade schools. Funds can also be used for online higher education, meaning you don’t have to attend classes in person for your expenses to be eligible.
The Bottom Line
There are other ways to save for college outside of 529 plans, and some experts even suggest alternatives like saving in a Roth IRA or a brokerage account, or even in a custodial account or a Coverdell Education Savings Account. However, 529 plans really are the best savings vehicles for the majority of people who want to begin saving for education expenses.
The reality is, 529 plans are widely available, easy to understand, and feature some serious tax advantages when used for education. When it comes to saving for college, these accounts are hard to beat.