529 Plan: Save Taxes, Save for College

When you’re deciding how to save for college, navigating a sea of eager 529 plan brokers can be quite the struggle. Before signing away your hard-earned money (not to mention your child’s future), here’s the scoop on two of the most common choices: 529 College Savings Plans and 529 Prepaid Tuition Plans.

How Is a 529 Plan Different from a Simple Savings Account?

A 529 plan (college savings plan) is a tax-advantaged savings plan designed to encourage stashing money away for future college costs. And by “tax-advantaged,” we mean 100% exempted from federal income taxes altogether. The Feds won’t tax you on earnings from growth or withdrawals. Sounds like a great deal, right? It definitely can be, as long as you do your research. Ask yourself the following Hows before going forward:

1. How many years do I have until my child will enroll in college?
2. How much money do I have to invest right now?
3. How much do I plan to contribute each month?
4. How likely is it that my child will go out of state for college?

529 Prepaid Tuition Plans

If you answered “not very likely” to the last question, a prepaid tuition plan may be your best option. The number one advantage of taking this route? This type of savings plan actually LOCKS IN tuition at the current rate when you open the account. Put the money in today, and your student applying to college in 2032 will pay today’s tuition. With college tuition rising at an average of 6% per year, this could equate to thousands of dollars saved! You can use funds for tuition and mandatory fees. You can use the Texas Tuition Promise Fund (“Texas Tomorrow Fund”) at any public two-year or four-year institution in Texas. If your student decides to go to a private university or an out-of-state option, you can apply the “transfer value” of your investment toward the cost of tuition and fees.

529 College Savings Plans

If you aren’t sure where your student will land, a 529 college savings plan may be a more practical option. This type of 529 plan is more like a traditional investment account. You can purchase one either through a broker or through the state directly. Most brokers charge set fees + .25 – 1% annually to manage your investments. This is all commission paid directly to the broker for making the sale. If you’d like to avoid brokers altogether, Texas offers 2 direct plans: the Texas College Savings Plan and the Lonestar 529 Plan.

While a 529 college savings plan does not lock college costs in, it is more financially flexible than a prepaid tuition plan. You can use the funds to cover tuition, fees, books, room and board, and other educational expenses. The funds are invested, which comes with standard market risk, but working with a broker can help minimize this. If your son or daughter has a private or out-of-state school in mind, the high contribution limits (many in excess of $200,000) to this type of plan could be a selling point.

Why Doesn’t Everybody Do This? What’s the Catch?

Much like a private retirement account, the tax benefits to college savings plans far outweigh the risks. However, risks do exist. Plans like these impact a student’s need-based financial aid eligibility. The FAFSA considers invested funds as parental assets and will likely disqualify a student from grant money and some federal student loans.  If for any reason money is withdrawn from a 529 plan and not used for college expenses, it’s subject to income taxes as well as a 10% federal tax penalty on earnings.

Before investing a cent, make sure your child, or “beneficiary” in investment speak, is college-bound. There is no way to predict the future, but you should at least know your options in the event he or she decides to forego college. These include sending your child to a trade school or community college (yes, 529 plan funds can be used outside of a traditional 4-year setting), sending yourself or another family member to college, leaving the money untouched for a future grandchild to use, or just withdrawing the money and taking the penalty (this one hurts a little).

Do the Research Now to Avoid Regrets Later

When it comes to your money, there is no such thing as too much information. Read up on all of your options before making a decision. Weigh the pros and cons of each, and consult with a broker or accountant if your research leaves you with unanswered questions. Don’t be afraid to ask for help. When all is said and done, you should feel confident and excited about your decision.