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  • Writer's pictureThe Garabedian Group, Inc.

Your Guide to Using 529 College Savings Plans

Updated: Apr 29

When it comes to saving for your child’s future college expenses, 529 college savings plans are one of the most popular options — and for good reason. These plans allow you to tuck away money for future tuition expenses without taking a hit from taxes.

However, there is a lot to learn to make the most of this tax-advantaged plan. To help you help you make the right decision, here’s a rundown of the details about 529 college savings plans.

Plan Options

When choosing the 529 college savings plan, you have two options: prepaid tuition or savings investment plans. Neither plan provides a tax benefit to making the original contributions. The benefit is that growth due to appreciation of the investments, if any, and earnings (dividends and interest) are tax-free when withdrawn for qualified education expenses. Both cover higher education expenses, and they go about it in different ways.

Although many states are phasing it out, prepaid tuition plans (if available) allow you to pay ahead for college, locking in the current tuition rate. Since tuition rises about three percent every year, this is a great way to make the most of your available funds. Since this option only covers tuition, not other qualified expenses like books, it has fallen out of favor in recent years. Also complicating matters is the fact that the pre-paid plan only allows you to select colleges and universities in your state.

The most common option is the 529 savings investment plan. When the time comes for college, distributions include part earnings/growth in value and contributions. The contribution part is never taxable, and the earnings part is tax-free if used to pay for qualified college expenses. This option allows you to securely tuck money away not just for tuition but also for room and board, books, and fees. The plan also can cover attendance at any college or university, including some out of the country.

For that reason, the flexibility of the 529 savings investment plan has been steadily winning out over the prepaid option. No matter which one you pick, you can deposit pre-tax funds up to your state’s limit each year.

Investment Strategies

When using tax-deferred 529 college savings plans, there are many different investment strategies to use in helping your balance grow year after year. The age-based strategy is the most popular as it starts aggressive and becomes more and more conservative as your child’s college years approach.

If that arrangement does not work best for your finances, however, then customizing it to fit is the best route. You can go with a static contribution each month, for example, keeping the payments the same until your child is ready to go off to college. Alternatively, you can deposit a set percentage of your income, increasing your contributions as your household income levels rise.

Maximum Contributions

529 plans allow taxpayers to put away larger amounts of money, limited only by the contributor’s gift tax concerns and the contribution limits of the intended plan. Multiple individuals can each contribute up to the gift tax limit each year without being subjected to gift tax reporting. This limit is $18,000 for 2024. There are no limits on the number of contributors, and there are no income or age limitations.

Front-loading contributions result in greater tax benefits. There’s a special rule that allows contributors to make up to five years of contributions in advance (for a total of $90,000 in 2024). By contributing a larger amount upfront, earnings can compound over a longer period.

529 College Savings Plan Fees

While helpful to those saving for college, 529 plans do have some fees to think about, including maintenance and investment charges. Where allowed, in-state deductions can usually offset these fees, keeping account upkeep expenses to a minimum.

If you decide to have a financial advisor help you establish and maintain the plan, keep their service fee in mind. Their service fees may include an hourly rate, or they could charge a percentage of your assets in the fund each year.

Steep penalties can also occur if you elect to withdraw funds for a non-qualified reason. A charge of up to 10 percent can apply to early withdrawals, as the plans are designed only to cover qualified education expenses for the named beneficiary. For that reason, all children should have their own 529 college savings plan, which helps ensure they have money for college and avoid hefty fees.

Deciding If a 529 College Savings Plan Is Right for You

Since policies can differ greatly from state to state, it is important to look at the features, benefits, and restrictions of the plans offered by your state. The most important differentiators to look at are the minimum contribution levels and tax benefits offered to in-state contributors.

Questions about the implications of 529 plans or other college savings options? Contact our office today for more information.

Disclosure: All content and information provided is for general educational purposes only and should not be considered professional financial or accounting advisory. For tailored guidance related to your situation, consult with a qualified business advisor.

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