Attending a four-year university is often one of the biggest investments parents make for their children. With tuition prices rising every year, it’s wise to start saving early. A 529 college savings plan is one of the best ways to do so. These savings plans are purpose-built for education savings and offer immense tax benefits. So, what do you need to know about these savings plans?
What are 529 college savings plans?
A 529 plan is a savings plan designed to help pay for education. Previously, it was specifically aimed at paying for post-secondary education; however, in 2017, the plans were expanded to cover K-12 education (for example, if your child attends private school). In 2019, it was expanded further to cover apprenticeship programs, vocational programs, trade schools, and even the repayment of student loans. Overall, the plans cover a broad range of educational pursuits. If plans change and the original recipient doesn’t attend any of these programs, you can always convert the beneficiary to someone else, including yourself.
These savings plans have tax advantages. Owners of the plans contribute after-tax dollars and are able to reap the rewards of compound interest as the funds grow over the long term. The money grows tax-free. Withdrawals are also tax-free as long as the funds are applied to qualified education expenses.
What are the types of 529 college savings plans?
There are two main types of 529 plans:
- Savings plans. These are the more common type. With this plan, the account holder contributes money, which is then invested in mutual funds. Account holders can select the type of investments, and how aggressive or conservatively they want the funds to be invested. (Aggressive growth can reap big rewards or big losses.) Most funds are invested more conservatively as the beneficiary reaches college age.
- Prepaid tuition plans. These are less common and are offered only in some states and for some institutions. These plans allow account holders to lock in tuition at current rates. (See the next question to learn about the increasing costs of college and why this may be an advantage.) Prepaid tuition plans are slightly more restrictive because they can only be used at specific colleges and can’t be used for room and board, as general savings plans can be. However, they could be a great investment if you know where the 529 plan’s recipient plans to attend college.
How much should I be saving for my kids’ college?
The cost of attending university grows every year. Rates tend to increase at about two times the rate of inflation. If you have a two-year-old today, you can expect to pay $55,929 for in-state public school by the time they are old enough to attend. The costs are even higher for out-of-state public universities tallying up to $98,071 and private universities at $126,426 per year. A college cost calculator {http://www.collegesavings.org/college-cost-calculator/} from the College Savings Plans Network can help you get an estimate for your child’s age and college plans.
Experts recommend parents save between $250 and $450 per child per month from birth. However, not all parents or grandparents can contribute that amount. Most college savings plans allow you to contribute as little as $25 per month to keep the account active. There may also be natural opportunities to contribute additional funds, including if you get a raise, on the recipient’s birthday, if they receive an inheritance, etc. Of course, many families supplement contributions from parents or grandparents with need or merit-based aid, including grants, scholarships, and loans.
How much can I contribute each year?
These plans have a maximum contribution amount each year. For 2021, that amount is $15,000 per beneficiary. This equals the “annual exclusion,” which is the amount you can transfer to someone in the form of a gift without incurring taxes. It is possible for those with the means to “superfund” a 529 plan. Superfunding involves contributing five years of gifts at once without being subject to gift taxes. A wealthy grandparent or parent may want to do this upon a child’s birth, for example, to maximize how much compound interest those funds will earn as the baby grows up. However, there are complicated rules about how to go about this, so it’s best to consult with a financial or tax advisor before superfunding.
What are the benefits to living in New Mexico?
There are both state and federal 529 plans. You don’t necessarily have to live in the state where you purchase a 529 plan, nor does the recipient need to attend college in the state where it’s purchased. However, if you reside in New Mexico and purchase a savings plan here, you can deduct your contributions off your taxable income when paying personal income tax. It’s one of only four states in the U.S. with unlimited deductions for residents.
Why should I use a 529 plan rather than a Roth IRA or IRA to fund college?
People associate IRAs and Roth IRAs with retirement savings, which is fair, since this is this account type’s main purpose. However, these accounts can also be used for qualified college expenses for yourself, your spouse, your child, or your grandchild. You can make education withdrawals even if you’re still below the 59 ½ age threshold for retirement withdrawals. The problem? Doing so comes with some potential hiccups. First, you’re taking money out of your retirement fund, which you probably need for a well-funded retirement. Additionally, that money can’t be replaced in the IRA unless you’re still working and are younger than 59½. Finally, IRA distributions can be counted as income on the next year’s taxes and financial aid applications, so this may affect the recipient’s eligibility for need-based financial aid.
Overall, 529 plans are a tax-advantaged way to save toward education for your child or grandchild — and a savvy way to support their future.
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