How to Set Up a 529 Plan
Your little one may be grasping a rattle now, but she’ll soon be tossing a mortarboard in the air before you know it. Translation: It’s never too early to start thinking about how your family will pay for college.
We know it’s hard to think that far ahead when your biggest concerns are covering the costs of onesies, diapers and daycare. But if you want a wake-up call, plug a few numbers into excel or a college cost calculator. If you have an infant now, assuming tuition prices continue to see 5 percent cost inflation a year, your total cost for four years of higher ed could be around $235,358 for an in-state public college or $538,171 for a private college.
What is a 529 plan?
Making a dent in that wallet-busting figure won’t seem quite as daunting if you get a jump on setting up a college fund. A smart way to do that is through a 529 plan, a type of tax-advantaged investment account designed specifically for saving for college. In a 529, your contributions grow tax-deferred, and your withdrawals down the line are exempt from federal and most state taxes — as long as you’re using the money to pay for qualified education costs.
Who can open a 529 plan?
Anyone 18 or older can open a 529 plan, as long as they are a U.S. citizen or resident with a social security number or individual taxpayer identification number. This means parents, grandparents, aunts, uncles, or even friends can open a 529 plan.
Who can I open a 529 plan for?
You can open a 529 plan for anyone, regardless of their age, and they don't have to be a family member. They just have to be a U.S. citizen or resident with a social security number or tax ID.
If you're wondering, can I open a 529 plan for myself? The answer is yes, as long as you're over 18, are a U.S. citizen or resident, and have a social security number or tax ID.
How to open a 529 plan
Wondering how to set up a 529 plan? Here are some simple steps to follow.
1. Compare your 529 plan options
Each state and the District of Columbia sponsors at least one 529 plan, but you’re not limited to using the one that’s “yours.” You can invest in any state’s plan, no matter where you live or where your child eventually attends college. One benefit of using your own state’s plan, however, is that you could get a full or partial state tax deduction on your contributions, if your state offers that benefit. (Otherwise, you don’t get a tax deduction on your 529 contributions.)
Also keep in mind there are two types of 529 plans: college-savings plans and prepaid tuition plans. College savings plans allow you to save for higher-education-related costs for an eligible educational institution in the country. A prepaid tuition plan, meanwhile, enables you to pay for tuition credits at participating colleges or universities at today’s prices. So if you’re positive you want your kid to attend your alma mater, for instance, you can use a prepaid tuition plan to lock in the cost of those credits now.
Savingforcollege.com is a great place to start seeing what options are out there. You can look by state or compare plans using their search engine. Some things to watch for when comparison shopping: fees, which can eat into your returns; the investment options the plan provides; the plan’s average performance; and whether your own state offers a tax break on your deductions.
2. Choose the 529 plan custodian and beneficiary
The custodian is the account holder and the person who controls the money in the 529 plan, including how the funds are invested. The custodian is usually one of the parents. The beneficiary is the person whose college costs you’re trying to cover, i.e., your child or another relative.
If you’re saving for your child, it may be better if a 529 is set up in a grandparent or other relative's name. If your student is the beneficiary of a 529 plan set up by another relative, it’s considered the other relative’s asset, and any distributions from the account will not be reported on the Free Application for Federal Student Aid (FAFSA) form. For this reason, grandparent-owned 529 plans should not affect federal financial aid (although it might affect aid offered by some private colleges). Another consideration here is control. If the grandparents or other relative is the owner of the account, they will have full control over it.
If you have more than one bundle of joy, consider opening separate accounts for each child, since the money has to be spent on the beneficiary you name — although you can switch the name of the beneficiary on your 529 down the line to another member of your family if you need to.
3. Decide how much to put into the 529 plan, and what to invest in
Think about how much you need to seed your account (some 529 plans require a minimum), as well as how much you think you can set aside on a regular basis to keep funding it. While your instinct is probably to contribute as much as possible now, don’t do so at the expense of other important goals like retirement — there’s no such thing as a merit scholarship for your golden years.
Much like other types of investment accounts, you can invest the money in a 529 plan in assets like stocks, bonds and money market accounts. Some plans may offer age-based funds as well, which will rebalance your assets for you automatically depending on when your child will be attending college — the closer the first day of college gets, the more conservative the asset mix becomes.
4. Use your 529 plan money wisely
The one drawback to 529s is that they have to be used for “qualified education expenses.” If you use the money for other purposes, you’ll have to pay taxes, plus an additional 10 percent federal tax penalty on earnings.
For K-12, 529s can only be used for tuition. But once you get to college, qualified expenses are more broad and include things like room and board, but also any school fees, books and tech expenses that are required for school, like the purchase of a laptop.
But what if your brilliant Lila or Liam gets a full ride, or opts to skip college altogether for the school of life? All is not lost. Remember that the beneficiary can be changed to another child, another relative — or even to you, if you’ve been pondering finally getting that second degree. 529 funds can also be withdrawn without penalty (you would still owe taxes on earnings) if the beneficiary receives a full scholarship, gets into a U.S. military academy, or meets other requirements.
All investments carry some level of risk including the potential loss of all money invested. No investment strategy can guarantee a profit or protect against loss. This publication is not intended as legal or tax advice. Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.