Most parents have a goal of avoiding student loans for their college-bound children. However, what they don’t realize is that saving money in advance in a 529 Plan can help them to offset the cost of college by growing their savings in an interest-free account.
529 plans provide a tax-friendly way of saving for your child’s education. Your earnings in a 529 grow federal tax-free. When you take out money to pay for qualified college expenses, you will not be taxed on what you contributed or the growth of that money. Other types of saving accounts you may own are subject to income taxes and capital gains taxes.
States also encourage their families to save for college. Over 30 states offer tax deductions or credits for 529 contributions. In Ohio, contributions up to $2,000 per beneficiary per year are tax-deductible (if you are invested in the Ohio plan).
529 plans are flexible and low maintenance.
Here’s what we mean:
- You can choose any state’s plan you want. You don’t have to pick the state you reside in, but be careful to check with your state for any tax benefits for contributing to your resident state’s plan.
- As the owner of the account, you control all distributions from the account. If the beneficiary chooses not to go to college or does not need the money, you can change the beneficiary and use the money for qualified college expenses for any relative you choose or even for yourself.
- 529 plans do not have any income or contribution limits. Your household income does not impact the amount you can save, and you are not limited by an annual contribution maximum. (It should be noted that the 529 does not have an annual contribution limit, but the annual gift tax exclusion of $15,000 per donor in 2020 and 2021 should still be considered. Most plans even allow an advanced 5-year gift of up to $75,000. You are also limited over the life of a 529 plan to a total maximum aggregate limit that varies based on your state.
- After you set up your plan, contributions can be automated, and you can select an investment plan based on the age of your child that adjusts to an appropriate mix of investments, as college gets closer. Think of it as a crock-pot for investments. You should check in occasionally, but no need to stir it up all the time.
- Most states offer a “direct” to consumer plan with relatively low fees (but be sure to pay attention to what they are when you sign up. If the plan is sold to you by an advisor, be sure to ask what the commission is and how that can impact your overall investment).
- Family members and friends can invest too. (Click here to learn more.)
Qualified expenses include tuition, room and board, required fees, books, supplies, and equipment (including computers). Tuition, fees, and books are also included for part-time students. Recently, 529 Plans have also qualified to cover K-12 education expenses (think: private school tuition).
Is it better to save or to borrow?
A dollar invested is worth more than a dollar because of interest, and of course a dollar borrowed costs more than a dollar because it is also subject to interest.
Say you just had a baby. Congratulations! You start investing $25 per week for the next 18 years for a total contribution over the 18 years of $23,400. Assuming a 6% interest, you will have saved $42,095 due to compounding interest and the time value of money. If you were to borrow $42,095 as a student loan with 6% interest over a 10-year repayment period, you will have paid a total of $56,081 when factoring in principal plus interest.
The $23,400 you invested provided you with $18,695 in investment gains for a total of $42,095 to pay for college. Borrowing that same $42,095 to pay for college will cost you $13,986 in interest and a total of $56,081. Which sounds like a better deal…$23,400 or $56,081?!
We like to say that it is never too early and never too late to save for college in a 529 plan. The danger lies in not doing anything.
Originally posted: May 2017
Updated: February 2021
