Personal Insights

How to Open a 529 College Savings Plan

Whether you’re currently basking in the joy of becoming a parent or already planning for your budding scientist’s education, it’s never too early to start thinking about how to pay for college.

With the average annual cost of tuition and fees reaching $9,650 for a public four-year in-state college, $24,930 for a four-year public out-of-state college, and $33,480 for a private four-year college, you may be anticipating spending a large chunk of change down the road.

Regardless of whether your child ultimately decides to attend your in-state alma mater or an out-of-state school, you’ll want to start them off on the right foot well before they start sending in their college applications.

If paying out of pocket is out of your financial scope, one option is to open a college savings account, like a 529 qualified tuition plan — a state-sponsored investment account in which federal taxes, and in some cases, state taxes, do not apply to distributions — to cover the costs when it’s time to send the kids off to college. From tax benefits to contribution limits, a 529 plan is a flexible and parent-friendly option, says Todd Edmondson, Financial Advisor for Regions Bank.

But before you open a 529 college savings plan, make sure you understand the basics.

Research Your Options

There are two types of 529 college savings plans: prepaid tuition plans and college savings plans. Prepaid tuition plans offer limited coverage of expenses but lock in future tuition rates at the current tuition rate for eligible colleges and universities, whereas a 529 college savings plan allows contributions to cover all qualified expenses — including tuition, room and board, fees, books, and computers — but don’t lock in the cost of tuition, which means that tuition rates will be likely to fluctuate. Keep in mind that each state offers their own 529 college savings plan or plans, and you aren’t obligated to use one of your state’s plans. Tax credits and contribution guidelines differ from state to state. Some state 529 plans allow non-residents to contribute to the plan.

"It varies by state, but it is a fairly small amount of money to contribute," says Edmondson.

Understand the Benefits

1. Contribution limits. Compared with an education savings account, which only allows for a $2,000 annual contribution, 529 college savings plans allow you to contribute up to the amount necessary for qualified education expenses. So if your child’s total cost of education amounts to $38,600 (based on tuition and fees for a public four-year in-state college), then you’re eligible to contribute up to that amount. Plus, contributions are gift tax-free up to $15,000 per year. There are methods that may be used to increase the amount you can contribute during a particular year, so ask your tax advisor if you have started late and need to make large contributions to try and catch up.
2. Tax-free distributions. When it’s time to make a tuition payment or buy books, the funds are distributed from your 529 plan federal income tax-free.
3. Account ownership. You are under no legal obligation to give your child access to the account, so you can make the decisions regarding contributions and distributions from the account. You can also change the beneficiary of the plan to another child, in the event one child doesn’t use all — or any — of the funds.

Consider the Disadvantages

1. Penalties. Withdrawals that are not used for the beneficiary’s education expenses are taxed and penalized. If your child decides not to go to college, you’ll be taxed on all the interest and capital gains earned on the account if money is withdrawn, in addition to paying a 10 percent penalty on the earnings portion of withdrawals. However, if your child receives enough scholarship and grant money to cover expenses, the 10 percent penalty charged on withdrawals may be waived.
2. Additional charges. Some 529 plans charge various fees and expenses to cover investment expenses and the administration of your account.

Consider Other Ways to Use Your 529 College Savings Plan

In the case that your child chooses to skip college, you may be able to change the plan’s beneficiary. If your child chooses to pursue a trade or vocational education rather than a two- or four-year education, you may be eligible to use your 529 college savings plan to fund their education. In addition, any money leftover after undergraduate can be applied towards graduate school.

Ask for Help

“The best place to start is with an advisor,” says Edmondson. A financial advisor can help you decide on the right plan as well as a monthly contribution amount that will fit your budget and help your child when it’s time to pay for school. Make sure the advisor understands your needs as well as your plans for your child. Consider whether you want your child to take out student loans and how they’ll manage student debt after graduation. A financial advisor can help guide you on these details and more.

Start Early

The sooner you begin contributing to a 529 account, the more time your money has to grow. For example, if you contribute $200 a month into a plan for 10 years and earned a 3.5 percent return, you could accumulate nearly $29,000 with the tax benefits.** You may want to start saving at least 10 years or more before it’s time to send your child off to college if you’re able.

Do some preliminary research to learn what options and tax benefits may be available that may work best for your family.

While other education plans and loan options are available, remember to consult with a financial advisor when you’re ready to open a 529 college savings plan to ensure you make the proper contributions and distributions.

**This example is for illustrative purposes only and the 3.5 percent return is not indicative of any actual investment. Actual investment results may differ substantially. Before investing in a 529 plan, investors should carefully consider whether the investor’s or beneficiary’s home state offers any state or other benefits available only from that state’s 529 plan.