As we know, college students who finance their education with student loans can expect to be saddled with debt for years to come. Facing that debt is a deterrent for teens who want higher education but can’t afford it on their own. When utilized properly and started early, 529 college savings plans can help your children avoid student loan debt and set them up to pursue the life they deserve.
How 529 College Savings Plans Help Avoid Student Loan Debt
Pew Research Center reports that 49 percent of adults aged 18 to 29 with a bachelor’s degree or higher also hold student loan debt. According to the same report, a good number of those struggle financially compared to those without that debt. And, many who financed college with loans feel like obtaining their degree feel wasn’t worth the financial hit they took to get it.
These are pretty sobering facts—circumstances no one wants their child to bear at the outset of their lives. But, 529 college savings plans can help avoid student loan debt. Now, there are two different types of 529 plans: investment accounts and prepaid tuition plans. The prepaid plan locks in the college and/or university tuition rate that’s in place on the day you open it and allows you to pay that price in the future when your child goes to college. This article covers the more well-known 529 investment savings plan. These investment accounts have the potential to build significant income for your child’s college education, which, in turn, helps them avoid that massive debt.
529 College Investment Savings Plan Details at a Glance
- Anyone can be named as a beneficiary of a 529 plan—even yourself.
- Contributions are made with post-tax dollars.
- Earnings grow tax free.
- Contributions cannot exceed the cost of the anticipated qualified expenses.
- Distributions are tax free as long as they pay qualified education expenses.
- Withdrawals of earnings from contributions that don’t pay qualified education expenses are added to gross income.
- Unqualified distributions can also incur a 10 percent penalty on top of the tax.
- Anyone can make contributions to help the account grow (parents, grandparents, aunts, friends).
- Contributions by one person must not exceed $15,000 a year for each plan/beneficiary to avoid gift tax liability.
- Married couples who file joint tax returns can contribute up to $30,000/year per each plan/beneficiary and avoid gift tax.
- An individual can take advantage of the 5-year election and pay up to $75,000 over a 5 years without gift tax liability.
- If one child doesn’t use their 529 funds, another one of your children or family members can.
- If the plan funds are not used, distributions of the contributions may be taken tax free, but distributions on plan earnings are subject to tax plus a 10 percent penalty.
What Are Qualified Education Expenses?
Qualified education expenses include college tuition, books, room and board. These are pretty hefty expenses, too. So, if you have a 529 for your child, the ability to pay any of these costs from those savings can be quite a relief—to you and your child.
It’s important to note that recent laws have expanded qualified education expenses to include a few other costs. Now, paying student loans and for funds used on apprenticeships registered with the U.S. Department of Labor are considered qualified education expenses.
Payment for K-12 private school tuition, computers, and software were recently added to the list of qualified expenses, as well. Some states haven’t updated their laws to handle private school tuition payments yet—so check with your state before you make a withdrawal for this.
Tips to Help You Choose the Right 529 College Savings Plan for You
Before you open a 529 plan, perform your due diligence in choosing the right one. You can open one for yourself or your child in any state, regardless of where you live. But each state has different rules, costs, benefits, and tax implications/benefits to consider.
You should also research the investment performance of the plan. Your goal is to avoid student loan debt, so you want to make sure the plan you choose has had overall success in its investment choices. While investment performance is never guaranteed, some plans have better track records over the years than others, which can be a key factor to help you decide which plan is the best for you.
Now, opening a college savings plan when your child is young may seem a bit premature. After all, you have years to figure this out before they go, right? Except—time flies. Before you know it, your child’s college days will be upon you. And you want to be prepared to make this transition from their late teens into early adulthood as easy as possible.
If started for your child early in life, 529 plans have the potential to amass quite a bit of wealth for college. As with retirement plans, the earlier you open and begin contributing to one the longer it has to build tax-sheltered income for your purpose. These plans are a good tool to use to help set your child up for success early in life—without burdening them with debt.
This article has been written for informational purposes only and should not be considered investment, tax, or legal advice. We encourage you to consult with the appropriate professional to help you navigate the process of choosing the best 529 plan for you or your children.