What is a 529 savings plan and is it right for my family?

February 14, 2019 by David Riedel

If you have small children (like me), you’ve probably heard a lot about how much college tuition costs will spike in the future and that a 529 savings plan is the best way to ensure you’ll have enough money to give the little whippersnappers a shot at a higher education.

First, it’s true that college tuitions rates climb more quickly than inflation, so if you’re looking at the numbers and it appears college is getting more expensive faster than everything else, you’re correct. Using the Bureau of Labor Statistics inflation calculator, you’ll find inflation rose at a rate of 1.5 percent between January 2018 and January 2019. According to U.S. News & World report, college tuition and fees far outpaces 1.5 percent.

Second, unless you (or a generous family member) are a multimillionaire with no chance of losing your fortune before the kids in question go to college, a 529 may be the way to go.

So what is a 529? Congress created it in 1996 and its legal name is “Qualified tuition program.” But that’s too wonky, so everyone refers to it by its IRS section: 529. And for the record, I’m writing about savings plans, not prepaid tuition plans.

The purpose of the 529 savings plan is to stash away money for your children (or grandchildren or nieces and nephews or whomever) and have it grow at a tax-free rate that eventually makes it worth more money than you’ve deposited over the years.

Let’s take a hypothetical. An owner (a grandparent) opens a 529 savings plan for your child. The owner names you, the parent, a successor-owner just in case something happens to them (such as death) before the child is college-ready. Finally, the child is the beneficiary.

The grandparent puts in money (there’s a cap; see this IRS explainer for details). Deposits are tax-free and so are earnings (as long as they’re used for the 529’s intended purpose; however, if you deposit more than the limit, you may be subject to a gift tax).

Now this is where things get a little more complicated. There are state and federal 529s, but you’re not hemmed in by your state of residence. For example, I live in Massachusetts, but if I chose to open a 529 in Ohio, that’s no problem. Some states offer an in-state income tax deduction. Some don’t. (For example, Ohio does. So does Massachusetts. California does not.)

Finally, when the child is ready to go to college, the money may be withdrawn to pay tuition, but there are limits, for example, on room and board. There’s no limit on how many 529 plans you can own or how many the child may use. Plus, as of January 1, 2018, up to $10,000 of your 529 may be spent per beneficiary on elementary, middle, or high school tuition per year.

But say you have two kids and the older one decides college isn’t for her. The money in the plan is transferable between siblings without penalty. You can make the younger child the beneficiary of the older child’s plan. Or, you could make the older child the owner, and she could eventually make one of her children the beneficiary. That’s super long-term planning, but the point is that a 529 is pretty flexible.

Here’s another benefit. Say you live in Indiana and your older child goes to Ohio State. The younger child goes to Harvard. Out-of-state tuition for OSU will run you, at today’s rates, about $30,000. Harvard tuition will cost roughly $45,000. You can use money left over in the older child’s 529 for the kid going to Harvard.

That’s a lot of information to digest in one blog post. So if you’d like to learn more about 529 savings plans, I’d suggest talking to a) someone you know using one, and b) a financial advisor. That way you can make an informed decision about whether a 529 savings plan is right for you and your family.

 

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