And no one wants their kid to be buried in debt.
The good news is theres an investment vehicle specifically designed for education expenses: the 529 savings plan.
It offers tax-free growth and tax-sheltered withdrawals for many education expenses.
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But before you open an account, its important to know how they work.
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What Is a 529 plan?
This means that if youre saving money specifically for education expenses, a 529 is perfect for you.
That means if youre at least 18, you could open your own account and make yourself the beneficiary.
More commonly, though, the beneficiary will be a child or grandchild.
There are actually two types of 529 plans: prepaid tuition plans and education savings plans.
Heres how each one works.
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Contributions to these plans are invested by the program you buy into.
The programs invest your money in hopes that the earnings will outpace rising tuition costs.
While 18 states once offered such plans, that number is down to just nine as of 2024.
Only six states currently make that guarantee.
Many plans penalize you if your funds are used for out-of-state tuition.
We cant account for the specifics of your circumstances.
Who Can Contribute?
you might contribute to these plans no matter what your income.
How Much Can You Contribute?
There is no contribution limit to a 529 plan account.
However, some states have a maximum balance ranging from $235,000 to over $500,000.
This will use up five years worth of your federal gift tax exemptions as the contributor.
However, its highly unlikely that youll have to worry about gift tax consequences.
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Do 529 Plans Affect Financial Aid Eligibility?
That means 529 plan investments have less impact on financial aid eligibility than they did in the past.
Financial aid eligibility is calculated by subtracting a students expected family contribution from the schools cost of attendance.
How Are They Taxed?
Earnings of both types of 529 plans are tax-free.
In 30 states, your contributions are deductible for state taxes, as well.
Your withdrawals will be exempt from federal and, in many cases, state taxes.
What Expenses Does a 529 Plan Cover?
Each year, you will report your 529 contributions and withdrawals to the IRS.
In some states, you could face an additional penalty.
How Does Money Grow in a 529?
(This does not apply to prepaid tuition 529s.)
For the average investor, though, Valley suggests target-date funds.
The set-it-and-forget-it nature of this option is a plus for many.
you might also elect to open a direct-sold 529, meaning you wont have a financial adviser.
Of course, this means youll save on fees typically around 1%.
How Do You Withdraw Money From a 529?
it’s possible for you to also have the money distributed to the beneficiary.
What Happens to Unused Funds in a 529?
You might wonder if 529 plans are too limited to make sense.
After all, what happens when your child gets that full-ride scholarship?
Or what if they dont go to college?
Once every 12 months, you could also roll over unused funds to another family members 529 plan.
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529 Plan Pros and Cons
Like any investment option, 529 plans have certain advantages and disadvantages.
But those special circumstances and preferences could be the difference for some.
Let us take a stab at paint such a picture.
Suppose youve only got one kid.
Youre saving for college, but you have less than $6,000 per year to put in that direction.
Youre funding your401(k)sufficiently, so you dont need additional investment vehicles for your own retirement.
With a 529, you contribute after-tax money; the same goes for a Roth IRA.
Your 529 withdrawals on qualified education expenses are tax-free.
If you save more than you need?
The point is, 529 plans are made to save for college.
So, if youre saving for college, theyre tough to beat.
But you may not be the run-of-the-mill investor.
There could be other options that make more sense for you.
