Ready to start saving for your children’s college? There are plenty of ways to get started, such as investing in mutual funds, a CD, a Coverdell ESA, a savings bond and so on, but a 529 savings plan is by far the most popular, widely used choice.

Similar to these other savings options, a 529 college fund is something you invest in early on to reap the full benefits. So what are the benefits, anyway, and what is a 529 college savings plan?

A 529 plan is an education funding account you can set up for yourself, your child or even your niece and nephew. It’s a tax-advantaged investment account that was specifically created for certain education expenses, such as tuition, and are state-run. They come in two groups—a prepaid tuition plan and a savings plan, which we’ll review later—and a nice variety of tax benefits that you and your family can take full advantage of.

In this article, we’ll cover everything you need to know about 529 plans, from the different types, investment options, the tax advantages and more so you can start saving today.

 

Prepaid Tuition Plans and Education Savings Plans

There are two types of 529 education plans you can choose from: a prepaid tuition plan and an education savings plan. While both plans offer tax benefits intended for saving for your child’s higher education, there are a few key differences. Let’s take a look at how each option works. 

Prepaid Tuition Plan

A prepaid tuition plan allows you to pay for your child’s future tuition by purchase college credits at today’s price, as long as it’s with a participating school. With college tuition consistently rising year after year, putting money into a prepaid tuition plan is a great way to save money while also enjoying the tax benefits of a 529 plan. This plan type gives parents peace of mind that their savings goals won’t change based on the prices of schooling going up.

Additionally, the United States Securities and Exchange Commission guarantee that prepaid tuition plans are backed by the state.

One thing to remember when opting for a prepaid tuition plan is that you or your beneficiary must be a resident of the state that is sponsoring the plan. Additionally, this 529 plan type comes with a limited enrollment period.

Education Savings Plan 

A 529 education savings plan, on the other hand, allows your contributions to be placed in investment funds, such as stocks and mutual funds. While this option may be riskier in the beginning where the performance of the investments can go up or down depending on the market, most of these plans will select more stable and less risky investments as your child gets closer to freshman year, when they’ll be ready for the funds. You can determine what your investment options are once per year.

Unlike a prepaid tuition plan, education savings plans are not guaranteed by the state nor are they federally insured. Additionally, you can enroll at any time throughout the year with this plan type.

529 Plan Fees

When it comes to fees, this depends largely on how much you invest as well as the organization running the plan you choose. Generally, fees will include a portion of the annual account amount plus maintenance fees.

Additionally, if you select an advisor-sold plan, you’ll need to compensate them for their service in managing the 529 college savings account.

Choose a 529 Plan Investment Option

As mentioned in the previous section, a 529 education savings plan allows you to select what investments you’re contributing to. How it works is you’ll be presented with investment options at the time of opening your 529 account. Once you make your selection, the value of these investments will rise and fall depending on their performance.

So how do you know which investment option to choose? Let’s take a look at the two primary investment options—age-based portfolios and static portfolios.

Age-based Portfolios

With this investment type, the allocation of assets will automatically change as the child ages over the duration of the 529 plan and will move towards less risky investments.

This option is ideal for parents who don’t want to think about managing their investments and those who just want to pick an investment and forget about it. One thing to keep in mind with age-based portfolios is how aggressive or conservative it is. This can vary depending on the 529 plan you choose. Every plan manager will have their own defined level of risk for a given age.

Static Portfolios

Unlike an age-based portfolio, the asset allocation of a static portfolio will remain the same over the duration of the plan unless you choose to reallocate the assets to other portfolios. In short, this investment type is best for those who are more experienced with investments and who may have a specific objective when investing.  

Static portfolios can be broken down further into two types: target risk portfolios and individual portfolios. Target risk investments will adjust regularly to meet their target. They typically have names like “Income Portfolio” or “Aggressive Growth Portfolio.” 

Individual portfolios will mirror their underlying investments, which use open-ended or exchange-traded mutual funds. This is a great option if you want to really customize your investments.

 

What Happens if the Beneficiary Doesn’t Go to College?

Some parents have reservations about opening a 529 college savings account simply because they aren’t sure if their child will even go to college. What happens then?

When it comes to your 529 plan, there’s no need to worry about whether or not your child goes to college. You can still use the money for non-education expenses, but you’ll be subject to a 10% penalty as well as taxes on earnings. But the money won’t be lost.

There are a few additional options available to you that won’t incur a penalty or your earnings being taxed. One option is to change the beneficiary on the account, which you can do at any time. The only caveat is that it can only be changed to another family member of the beneficiary. You can make this change once per year without incurring any fees. Additionally, you can always change it back if your child decides to attend college after all.

Another option is to use the 529 plan funds for K-12 education, where you can use up to $10,000 per year. Many parents don’t realize that 529 plans can be used not only for college, but K-12 and postsecondary education, which includes trade school, community college, and certificate programs. 

If your child has a disability which you believe will prevent them from attending college, you can convert your 529 plan to another type of tax-benefited account known as the Achieving a Better Life Experience (ABLE) plan which can be used for qualifying expenses.

Finally, there are special instances where the 10% penalty on non-educational expenses can be waived, but they’ll still be subject to income taxes on the earnings. These extenuating circumstances include death, disability, military attendance, and scholarships.

 

Who Can Open a 529 Plan?

Pretty much anyone can open a 529 college education fund, such as parents and grandparents. For parents, this would be either the mother or father of the beneficiary. Parents benefit most by opening a 529 plan early while their future college grad is still a young child or even baby so the account will have plenty of time to grow.

You can even open a 529 education fund for yourself as long as you’re 18 years or older. This could benefit those looking to change careers or go to graduate school. While you won’t have much time to build up your savings, you can still be eligible to claim a deduction on your state taxes for your contributions.

 

Who Can Be a Beneficiary

A 529 plan beneficiary must be a family member, which, according to the IRS, includes blood relatives as well as relatives by adoption or marriage. 

To be more specific, a family beneficiary includes:

  • Child, foster child, adopted child, or stepchild
  • Sibling or step-sibling
  • Spouse
  • Father, mother, step-father, step-mother
  • Son-in-law or daughter-in-law
  • Father-in-law or mother-in-law
  • Aunt, uncle, or their spouse
  • Niece, nephew, or their spouse
  • First cousin or their spouse

 

Tax Advantages (qualified education expenses)

While a 529 savings plan offers some excellent benefits, such as its flexibility and minimal impact on eligibility of financial aid, the main benefit is the tax advantages.

529 plans offer tax-free growth and tax-free withdrawals, as long as they’re used for qualified education expenses. This allows you to save money by making contributions without the need to pay taxes on your earnings. Additionally, most state-run plans will offer their residents a partial or full deduction or tax credit for contributions made to a 529 plan.

 

Does a 529 Plan Impact Financial Aid Eligibility?

How much financial aid a student is eligible to receive depends largely on their Expected Family Contribution (EFC), which essentially assesses the financial fortitude of a family by considering the student’s and parent’s assets and income.

Ultimately, the impact a college savings plan can have on a student’s financial aid depends on the type of plan and the plan owner. If the account is owned by a parent or dependent student—generally an undergrad still living with Mom and Dad—then a 529 plan will actually have a better impact on financial aid eligibility than other college savings account types.

In short, money saved in a 529 plan owned by the student or parent has the least financial aid eligibility reduction than a student’s custodial bank or brokerage account, a grandparent-owned 529 account, or a Roth IRA account.

 

What Expenses are Qualified and Non-Qualified?

The tax perks for a 529 college fund are only available for qualified education expenses. This includes the following:

  • Tuition and fees (limited to $10,000 each year for K-12 education)
  • Books and supplies (college only)
  • Internet access and computers (college only)
  • Room and board (college only)
  • Special needs equipment (college only)

A few commonly confused non-qualified expenses include:

  • Transportation and travel costs 
  • Health insurance
  • College testing and application fees
  • Fees associated with extracurricular activities
  • Student loans

 

Contributions to a 529 Plan?

 

When it comes to contributions made to a 529 savings account, there are a few things to keep in mind. The first is the annual contribution limit. Unlike Roth IRA and 401K accounts, the IRS doesn’t specify a limit for 529 plans. Each state runs its own 529 plan and they determine the rules and maximum contribution limits—so the amount will vary depending on where you get your plan.

 

Gift Taxes

You’ll also want to consider the fact that contributions made to a 529 account are counted as gifts for tax purposes. As of 2019, gifts amounting up to $15,000 per individual will qualify for the annual gift tax exclusion. The excess amount will have to be reported on Form 709 when filing your taxes.

 

5-Year Election

You can contribute up to $75,000 in a 529 account if it’s treated as if it were spread out over a five year period. A 5-year election needs to be reported on a Form 709 for each of these five years. So if you deposit $50,000 into a 529 plan, it will be applied as only $10,000 each year, resulting in a $5,000 unused annual exclusion each year.

 

Can Grandparents and Family Members Contribute?

 

What’s great about having a 529 education plan is that it’s contributions aren’t limited to the plan owners. Friends, grandparents, and other family members can make contributions too. A contribution, no matter how big or small, can make an excellent holiday or birthday gift and will have a longer-lasting impact on your child’s future.

By opening a 529 college savings account with U-Nest, an easy-to-use mobile app designed for establishing tax-free college savings, you can sit back and watch your money grow from contributions made by you and loved ones. It’s easy, efficient, and best of all, it takes less than five minutes to open your account. If you’re a grandparent, we recommend investing in a 529 Plan, one that gives you peace of mind for you grandchildren’s future.

 

 

Final Thoughts

 

There are plenty of ways to start saving for your child’s future, but the key is to start today. A 529 plan offers the best tax advantages for contributions, choosing investment options can be simpler than you think, the money in the account won’t be lost if your child doesn’t attend college, and it’s easy to get started.

 

You can open an account today by downloading the U-Nest 529 Plan app to start saving for your child’s financial future.

 

 

 

Ksenia Yudina, CFA, MBA

Founder and CEO

Ksenia is the Founder and CEO of U-Nest, the first mobile app that makes it easy for families to save for college. As an entrepreneur and finance professional, Ksenia has focused on alleviating the impact of student debt on families across the economic spectrum. Previously, Ksenia was a Vice President atCapital Group/American Funds, the largest 529 provider in the U.S. In this role, she played a leadership role in helping parents plan and manage their finances, with a focus on the future well-being of their children. Prior to Capital Group/American Funds, she was founder of a residential real estate company. Ksenia earned her bachelor’s degree in finance from CaliforniaState University Northridge, and an MBA from UCLA’s Anderson School of Management.

Mike Van Kempen

Chief Operating Officer

Mike joined U-Nest in September 2019 as COO. He was previously at Acorns, a financial wellness platform, where he spearheaded the analytics and growth initiatives. Mike successfully expandedAcorns’ paid acquisition strategy, adding over 4.5 million investment accounts. Mike began his career in strategy & analytics at Belly, a Chicago-based loyalty startup in 2012. At Belly, Mike led projects that fueled growth across all aspects of the business, growing the customer base from1,000 to over 11,000 merchants, and accumulating a membership of over 2 million customers.Mike holds a B.B.A. in Finance from Loyola University of Chicago.

Steve Buchanan

Chief Technology Officer

Steve has over 20 years of experience in delivering digital innovations in the financial sector. Steve previously orchestrated product architecture and innovation as a Solutions Architect/ Fintech consultant at Union Bank. Prior to Union Bank, he was Chief Architect and Director of Engineering at Calypso, a Silicon Valley startup, where he architected and built multiple financial solutions. He was also Head of Global Integrations at Globe One in Vietnam where he integrated its Peer-to-Peer lending products into core banking solutions. Steve also built the first ever electronic Equities &Equity Options trading systems for Scottish stock brokers Wood Mackenzie (acquired by CountyNatWest). He is a graduate of Edinburgh University.

Peter Mansfield

Chief Marketing Officer

Peter has built an impressive track record in multiple financial industry segments including payments, credit/prepaid cards and lending. He has played an instrumental role at a succession of financial industry leaders, co-founding companies such as Brand3 (acquired by American Express) and PropertyBridge (acquired by Moneygram), and, as the early stage marketing lead at Marqeta (where he was team member number two), BillFloat and WallabyFinancial (acquired by Bankrate).He has helped fast-growth companies reach an aggregate market value of close to $8 billion. Peter holds a bachelor’s degree in economics from the University of Angila, UK.

Sonya Kidman

Client Relationship Manager

Sonya Kidman is a Customer Success professional with a decade of experience in advocating for consumer through user research and genuine empathy. Sonya specializes in user behavior and regularly attends national and global training sessions in wellness and people analytics tools. Sonya is a true global citizen was born in Russia, grew up in Israel, lived and worked in Canada and NewZealand. That global expertise along with an undergraduate degree in Sociology from Tel AvivUniversity have helped to shape a bullet-prof Sonya's framework to develop a winning customer strategy.

Frank Mastrangelo

Board Member

One part banker and one part technologist, Frank spent his early days with the Annenberg Foundation and PNC Bank. His career path led him to Jefferson Bank, where he led the build-out of its electronic banking platforms, and where he would forge a powerful alliance with The Bancorp co-founder Betsy Z. Cohen. As President and COO of The Bancorp from its inception in 1999 Frank played a critical role in helping the organization become an industry bellwether for branchless financial services and a global leader in payments. For this, he has become a widely respected fintech expert, and thought-leader. Frank was recognized in 2013 by Banking Innovation, a leading industry journal, as an “Innovator to Watch.” and as one of the innovators shaping the future of banking. Frank is a graduate of West Chester University of Pennsylvania.

Disclosure

College Savings Calculator is a hypothetical tool that demonstrates how monthly contributions, age-based asset rebalancing, and tax savings may impact the long-term value of your account, and do not take into account a portfolio’s underlying investment management fees. Calculations assume the private institution cost inflation is 2.8%, public out of state cost inflation is 3.9%, public in state cost inflation is 2.7%. Portfolio is assumed to have only stocks and bonds. Monthly equity returns are based on the historical data from the 10-year track record of the stock market (SPY). Monthly fixed income returns are based on the historical data from the 10-year track record of the bond market index (AGG). The current college expenses are provided by the collegeboard.org. Actual account performance may differ due to market fluctuations, changes in recurring investments, and asset allocation. The information provided here is for illustrative purposes only and does not represent actual or future performance of any investment option and is not intended to predict or project the investment performance of any security or index.