According to the Education Data Initiative, 86% of parents have put away enough savings over the years to help pay for their children’s higher education. However, a study from Fidelity Investments shows that parents are on course to cover only 29% of their funding goals when college comes knocking.
Hence, it’s best to have a plan in place that facilitates convenient saving and investing over time. In particular, a 529 plan is an excellent choice for many reasons, including tax exemptions, its impact on FAFSA eligibility, and advantageous contribution limits, among many other benefits.
Here are six reasons why you should start saving for your children’s college tuition costs with a 529 plan:
1. Favorable Tax Obligations
Contributions to your 529 plan can be made with after-tax dollars, much like a Roth IRA or Roth 401(k). However, unlike a Roth IRA, most states (over two-thirds) offer state income tax deductions or tax credits if you fund a 529 plan. Besides the potential tax breaks, any earnings from your investment aren’t taxed if you use them for any qualifying educational purposes. Qualifying expenses include tuition, accommodations, meals, books, and computers.
2. Reasonable Financial Aid Treatment
A 529 plan that’s owned by a dependent student’s parent is not counted as an asset by FAFSA. Neither is one that is owned by non-parent family members such as grandparents. These assets are calculated at the most favorable rate, so they don’t have a significant impact on financial aid. However, in the case of a plan owned by non-parent relatives, the student would be required to report withdrawals as unearned income. The figure would be calculated at the least favorable rate, which would affect financial aid eligibility.
3. Flexibility of Use
In addition to college expenses, you can also use a 529 plan to take care of K-12 tuition costs, with an allowance of up to $10,000 annually. This type of plan also allows student loan repayment of up to $10,000 per borrower. However, there are a few expenses you cannot pay for with a 529 plan, such as homeschooling and college application fees.
4. Generous Contribution Limits
Did you know 529 plans have significantly high annual contribution limits of up to $16,000 for individuals or $32,000 for couples? This limit is much higher than other education funding plans, such as a Coverdell ESA that’s capped at only $2,000 annually for all sources. The superfunding feature is a bonus, as it allows you to fund up to five years’ worth of contributions at once without attracting gift taxes.
5. A Range of Choices
Almost every state offers 529 plans, and you can choose to fund an account from any state regardless of residency. You can also choose between two plan types, including a(n):
- Education savings plan: This investment account can cover future education expenses and is the most commonly used.
- Prepaid tuition program: This program lets you cover future college expenses at current rates. However, this plan is often only available at select institutions.
6. The Ability to Change Beneficiaries and Investments
Federal law allows you to change the investment up to twice annually or when you change the beneficiary, which brings us to the next point. You can change the beneficiary, allowing you to designate the funds to another child. This option also allows you to set up the college fund for an unborn child under your name and transfer it once they are born.
The Advantages of a 529 Plan are Truly Endless
You now have six reasons to use a 529 plan. Remember, you can choose which state’s plan to use and the investment type. Consider learning more about the details of a few different plans and the investment options they provide to find your perfect fit. Good luck!