The Ins and Outs of 529s: What You Should Know About College Savings
Terrified of what college might cost by the time your child turns 18?
We can’t blame you. And if it seems like prices are far more expensive than when you went to school, you’re right: The average price of a private four-year college in the United States (including tuition, fees, and room and board) now tops $40,900 a year, a 14% increase in the last five years.
While these blistering increases show little sign of slowing, many parents who want to help their kids shoulder the expense of higher ed are looking for smarter ways to save.
One of the best places to start is with a 529 college savings plan. While there are a few other options to earmark savings for education, such as Coverdell Education Savings Accounts, “529s are almost always the best option for saving for college,” says Natalie Taylor, a CFP® with LearnVest Planning Services. “They have both flexibility and tax benefits that often make them more effective and wallet-friendly than other college savings vehicles.”
Since the plans were created in 1996, they’ve become an increasingly popular savings option. As of the end of 2013, more than 10 million Americans had invested nearly $204 billion in 529s, about six times as much as they had a decade ago.
But not every 529 is created equal—each state sponsors their own version (or two), and allows both local residents and non-residents to invest. That’s why we consulted CFP® Taylor, as well as Joe Hurley, founder of savingforcollege.com, a website that specializes in 529 plans, to help us figure out how a 529 works, what you should know about using this vehicle and how to find the right plan for you.
What Is a 529?
529 plans, named for the section of the Internal Revenue Code that created them, are state-sponsored, tax-advantaged savings accounts that can be used to pay for qualified college costs—meaning tuition, fees, room and board, textbooks and even necessary technology. The funds can be used at any accredited school, public or private, anywhere in the country and occasionally overseas. Similar to a Roth IRA, money you contribute to a 529 will already have been subject to federal income tax, but once inside an account, the funds grow tax-deferred.
Most of the money in 529s today is invested in age-based portfolios, which are similar to target-date funds used for retirement savings. As a child nears college age, the investment mix gets more and more conservative. “It’s the ‘set it and forget it’ approach, where allocations are automatically adjusted as your child gets older,” explains Hurley. When the money is used for the approved expenses listed above, both your contributions and the gains come out tax-free.
All 50 states and the District of the Columbia currently offer at least one plan, sponsored by the state and typically managed by a financial services company. You don’t have to be a resident to invest in a state’s plan, but if you do choose your in-state option, you may be eligible for state tax deductions or credits.