It’s no secret that higher education costs have increased in recent years. According to the U.S. Department of Education, over 43 million Americans owe an average of almost $38,000 in student debt. But did you know bachelor’s degree holders earn roughly $1 million more than high school graduates over a lifetime? While education may be pricey, it plays a large role in earnings over time.
With costs on the rise and financial aid a challenge, it’s no longer enough to simply put away money in a standard savings account for college expenses. If you plan to put a child through school someday, you should make investment decisions now to make sure you can afford it. A great way to do this is with a dedicated college savings plan—namely, a 529 plan.
What is a traditional 529 plan?
A traditional 529 plan, named for the section of the Internal Revenue Code that governs their use, is an education savings account that covers the costs of education, including room and board, tuition, fees, technology and books. These plans use an investment account to offer a return on contributions with tax benefits that we’ll discuss below. You can choose a portfolio based on your risk tolerance, investment objectives and when you’ll need the funds.
The account owner is typically the parent. You select a beneficiary and can change that designated beneficiary anytime. This comes in handy if your child decides to forego college or gets a big scholarship and doesn’t need all the money. You can preserve the tax deductions by changing the beneficiary to a sibling or other person for educational use.
Anyone, including friends and family members, can open a 529 plan, but the more time you have before withdrawals are needed, the better. As with any investment, consistent contributions over time and a diversified investment portfolio of mutual funds, bonds and other investment options are the keys to success.
Benefits of using a 529 plan
Tax advantages offered by 529 plans make them a great tool for building an education savings plan. Earnings in the account are tax-free for both you and the beneficiary as long as they’re used for qualified education expenses—not just college. They can also be used for K-12 tuition, apprenticeship programs and student loan repayments.
All 50 states offer some sort of traditional 529 plan. In some cases, you may be able to enroll in a plan offered by a state other than the beneficiary’s home state.
If your income falls below a certain level, you may be able to access additional federal and state benefits. Some employers offer matching or bonus contributions to encourage savings goals.
What’s a prepaid 529 plan?
A prepaid 529 tuition plan is another option for parents planning further ahead for education. A prepaid plan locks in the price of a qualified tuition program at an in-state, public educational institution as it is today, even if actual enrollment is years away. So, if you’re sure your child will go to that school, you can have tuition paid for in advance.
Since a prepaid plan account locks in a lower tuition rate, there’s no need for the underlying investment to be widely exposed to the stock market for growth purposes. You decrease your risk by accepting the cost of college at the time you start saving versus gambling on what it will cost in the future.
If a beneficiary decides to go to school elsewhere, they may not get the most out of the plan. They’ll still be able to use all the money, but it may not cover current costs at another school. These plans aren’t offered by all states, and each state’s plan is a little different, so it’s important to research options based on where a beneficiary plans to go to school.
Maximize your return
Whichever plan you choose, don’t underestimate the time it takes for investment returns to grow. If you can, set up automatic deposits with the program manager but make extra deposits from time to time. Some savers even contribute to both traditional 529 plans and prepaid plans to maximize coverage of college costs and state and federal income tax benefits.
Education allows students to become professionals and achieve a higher quality of life. Give that gift to your child by opening an account to fund their future and, ultimately, their success.
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This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.