Average tuition and fees last year at public universities ran students who live in-state about $9,410 and out-of-state students $23,893, while private college attendees paid $32,405, per The College Board.
And that’s only for a single year. If the present trajectory persists, those amounts are likely to climb further.
Look into the 529 college savings plan, a tax-favored investment account created specifically to let you set aside funds now for your kids’ college costs later.
Legally called “qualified tuition plans,” these programs are run by state governments or educational institutions. The name comes from the section of the Internal Revenue Code that describes the rules.
Every state and the District of Columbia provides at least one 529 plan. You may open as many accounts as you’d like in any state, regardless of where you reside.
There aren’t income limits for the account owner or the beneficiary, nor are there annual contribution caps, according to the IRS.
Still, you can’t contribute beyond what’s needed to cover the beneficiary’s college costs. Each state establishes a lifetime contribution ceiling for its 529 savings plans, which ranges roughly from $235,000 up to $511,000.
“It’s really an advantage for parents if they start early to build a savings strategy for their kids so they’re better positioned after high school to afford college costs,” says Jolene Ignarski, a senior branch manager at Fidelity, which oversees 529 plans in four states.
What is a 529 Plan?
There are two main varieties: prepaid plans and savings plans.
A prepaid plan lets you buy tuition units from participating colleges and universities at current prices. This approach is meant to grow in value at the same pace as tuition — in essence, you lock in today’s tuition rates.
These plans typically cover tuition and fees, though some permit using surplus tuition credits for other expenses such as room and board.
Prepaid plans often impose age or grade limits on beneficiaries. Numerous state programs are guaranteed or underwritten by state governments.
There’s also the Private College 529 plan for independent colleges and universities, which applies to 280 institutions, including MIT and Vanderbilt.
“Private College 529 is a prepaid tuition program that lets families save on college by purchasing future tuition at today’s rates,” its site explains.
In fact, a certain credit card can even make contributions to your 529 plan — just for using it.
A savings plan lets you open an account and select investment choices for a prospective student, though it doesn’t lock in college costs the way a prepaid plan does.
These savings plans are broader, and withdrawals are usually permitted at any accredited college or university for tuition and required fees, as well as room and board and necessary supplies like textbooks and computers.
Investment choices include stock mutual funds, bond funds, age-based portfolios, money market funds and more. Like other investment accounts, the value of your money will fluctuate with the market, so there is investment risk.
States generally don’t guarantee these accounts. There are no age restrictions, so both adults and minors can be designated as the beneficiary.
Tax Benefits Offered By 529 Plans
One of the greatest perks of 529 college savings accounts is that anyone can contribute, making them especially popular with grandparents and relatives. They can literally gift education for a birthday or holiday.
Another upside is that earnings in the accounts are exempt from federal income tax, and often from state and local taxes, provided withdrawals are used for eligible college expenses such as tuition and room and board.
If you withdraw money from a 529 savings plan and it’s not used for qualified education costs, you’ll owe income tax plus a 10% federal penalty on the earnings.
With both kinds of 529 plans, if your child chooses not to attend college, you can change the beneficiary to another child or to yourself. Still, distributions should be used for qualified education expenses.
If your child dies, you won’t incur the 10% penalty when closing the account, but you will owe income tax on any gains.
Some states provide additional incentives — like matching grants or account bonuses — to motivate families to begin saving sooner rather than later.
These accounts can present other tax advantages as well.
Grandparents who wish to transfer assets to future generations might opt to put funds into a 529 plan. The contributions are removed from their taxable estate, and they can gift up to $14,000 per year without triggering the gift tax.
Is a 529 Savings Plan Right for You?
One important consideration when figuring out whether a 529 plan fits your needs: you can borrow for college, but you can’t borrow for retirement.
If your resources for saving are limited, it typically makes more sense to prioritize retirement accounts over a 529 plan.
“Think of it like airlines instructing you to secure your oxygen mask before helping others — the same principle applies here,” says Margaret Munro, author of a guide on college savings. “If you don’t have sufficient savings for retirement, where will you turn?”
Both kinds of 529 plans are restrictive — withdrawals are intended only for education expenses. Other savings vehicles are more flexible, so weigh how you’d respond to unexpected needs that might require tapping your savings.
“Are you setting aside enough for other eventualities, such as retirement, job loss, illness, etc.?” Munro asks. “Savings that can be used for a variety of needs are often preferable to funds limited to specific uses.”
It’s also wise to consider whether you’ll save enough in a 529 plan to cover college in full, or if you’ll need to rely on additional sources.
Depending on who owns the account, the school the beneficiary attends and your income, a 529 plan could affect your child’s eligibility for financial aid. Many of these plans carry sizable fees, as well.
Generally, a student’s federal financial aid is impacted least if a parent owns the account rather than the student or a grandparent.
That applies to federal aid, though individual colleges may use different formulas for their own aid packages, so check with any specific schools you’re targeting.
All in all, while a 529 plan can be an excellent way for some families to save, it won’t be the best fit for everyone, Munro notes.
“These accounts can restrict your options, be costly to maintain and will likely be considered in the financial aid process,” she says.
Your Turn: Are you putting money aside for your child’s college costs?
Also consider learning more about options like the 529 plan as you build a strategy for funding higher education.
