What Is a 529 Plan? Here's How Can It Help Fund Your Child's College Education
It can be used for tuition, books, and other qualifying expenses.
When it comes to preparing for higher education, there is so much more to it than enrollment, choosing a major, or outfitting a dorm room. Aside from student loans and applying for scholarships, there is a dedicated savings account called a 529 plan that's intended to help you save for schools nationwide.
According to Rita Assaf, VP of retirement and college leadership at Fidelity Investments, a 529 plan is similar to a company's 401(k) or IRA, as it is a tax-deferred growth on any earnings as well as federal income tax-free distributions for qualified expenses. A few of the college-related qualified expenses under this plan include tuition, room and board, books, and school supplies.
The biggest advantage for parents looking to grow their child's 529 plan is that it's tax-free. "While you pay taxes on the money you contribute to these plans, you aren't taxed on any gains from your 529 investments," explains Colleen McCreary, chief people officer of Credit Karma, "so long as you use withdrawals for qualified education expenses. Plus, in many states, you can claim contributions as a tax deduction or credit on your state income taxes."
Another advantage to growing a 529 plan is that by doing so, you're creating certain saving priorities. "Saving in a dedicated account allows families to earmark savings for their child or grandchild's future education," says Assaf. "This can be helpful when families are balancing many different savings priorities in addition to day-to-day expenses."
How to Choose the Right One for You
Whether you opt with a provider like Fidelity or another, opening a 529 plan is easy and can be done virtually. McCreary recommends doing some online comparison shopping beforehand to check different states' options and, particularly, the tax benefits your own state offers. According to the experts at Fidelity, parents or guardians need to have the beneficiary's personal information, including their social security number at that designated time of opening an account.
For those starting the process, McCreary says to keep in mind the guidelines for unqualified withdrawals not related to higher education. "You may pay a 10 percent federal tax penalty on the earnings plus regular state and federal income tax on that withdrawal," she explains. "If your contributions, plus any other gifts, to a particular beneficiary, are more than $15,000 in a year, starting in 2018, you could trigger gift taxes."