Saving For Kids' College Education—What You Need To Know: TOP 10 FAQs about 529 Plans
By moneyhipmamas on September 09, 2013
Does saving for your kid’s college education seem like a good idea, but that’s about as far as you’ve thought it through? Luckily for you, I’ve already gone through the pain of researching 529 plans for you (Don’t feel too bad for me—I voluntarily got a Masters in Accounting with an emphasis in taxation, so clearly I have a weird sense of what's "interesting"). Browse through these 10 FAQs and if you still have questions, shoot me a comment. I’ll either answer it here or in my next post about saving for college.
A quick note on the pin-it button: I know Pinterest is big for recipes, crafts, fashion, etc. Occasionally I see stuff like inspirational quotes and "funnies." Well, here at MHM, we are on a personal mission to make Pinterest come alive with other kinds of content that would greatly improve people's lives, such as Personal Finance. Feel free to join us in the revolution by creating a Personal Finance board in your Pinterest account (you can even give it a clever name if you want, like "One For The Money" and start pinning our images to help get the word out (and keep track of things you want to apply to your own finances).
1. What is a 529 plan? Why Open One?
529 Plans are tax-advantaged accounts to help you save for higher education (aka: college). The money you contribute will be invested and (to motivate people to save for college) the government allows those contributions to grow and be withdrawn tax-free when used for qualified education expenses. Although plans cannot guarantee returns, they generally grow at market rates.
You can check out each fund’s historical performance by going to their website. For example, Utah’s 529 plan (UESP) website is here. To see their performance, click on the sidebar's “Get the details” and check out page 45. Their “aggressive growth” performance since inception for a child 6 and under was about 10% (better than savings account rates? I would say “YES!”)
Example: You contribute $50/month to your kid's college fund. What would be the difference if you did this in a regular savings account that earned, say, 1% interest (taxed) vs. a 529 plan that, in the long term, earned about 7% (not taxed). Only a 6% difference in returns, how much could that matter? QUITE a bit, actually--almost double. After 18 years, this is how much you'd have:
Big difference, huh? Welcome to the world of investing!
What this means: Although I can’t predict the future on what market rates will be, they'll most likely be a LOT better than savings account rates. Plus, moving it out of a regular savings account will prevent the temptation to spend that money on other things.
Note: Each 529 plan must have one designated beneficiary (aka: the person you’re trying to send to college).
2. What if I want to change the beneficiary (the person who benefits from the account)?
You can change the beneficiary to another member of his or her family, as defined here.
What this means: Let's say you open an account for your first born. They choose not to go to college or they don’t use up everything you saved for them. You could roll this over to another sibling (or another relative included on this list) and use it for their college expenses.
3. What if my only child chooses not to go to college? Is that money recoverable?
If the beneficiary chooses not to attend college, another related beneficiary may be named (see question 2). Otherwise, if the funds are withdrawn for a purpose other than qualified education expenses, the earnings will be taxed and assessed an additional 10% federal tax.
What this means: 529 plans can easily be rolled over to provide for the educational expenses of any related beneficiaries. But basically, unless you plan on dedicating your 529 contributions to educational purposes, it may not be the best choice for you.
4. What if my child gets a scholarship?
If the beneficiary receives a scholarship, you can withdraw that amount from your account without penalty or additional tax (that's good!).
What this means: If your kid gets a scholarship, good for them! You won’t be penalized.
5. What are qualified expenses?
Tuition, fees, books, as well as room and board. And this isn't just for state schools--the money can be used for private schools, including some technical-type schools.
6. What fund should I choose?
Check out your state’s plan to start. There may be tax advantages for enrolling in your state of residence, but you can enroll in almost any state’s plan (e.g. you can live in California, enroll in Utah’s 529 plan and send your kid to college in Massachusetts). So if your state doesn’t offer anything in the way of state tax benefits and you find another state’s plan more appealing (lower plan fees and better returns), you may decide to invest elsewhere. For example, even though we live in California, their 529 plan doesn’t currently offer any state tax deduction or credit. I personally think the Utah Education Savings Plan is great so that’s where we chose to open our son’s 529 account. Each plan is completely different, so take a look at several plans, including the one(s) in your state of residence and compare different features (e.g. state tax and other benefits, fees, etc.) before choosing. Savingforcollege.com has a pretty nice way to compare 529 Plan features here. Or, for an easy at-a-glance comparison, check out their “5 cap ratings” here.