Everyone can agree that getting a college education nowadays is very important, yet it is also costly. You need to spend more than a couple thousand dollars just to get by in one semester of college.
While there are a lot of ways for you to fund your college, there is one that is quite effective and efficient in covering your college education costs. 529 plans are great at covering the cost of higher education in the US.
There are a lot of options with 529 plans since there are many different types. In this guide, you’ll learn more about weighing the upsides and downsides of 529 plans.
What is a 529 Plan?
529 plans are the answer to the rising cost of college education. In the past, 529 plans were the solution to cover the cost of postsecondary education costs.
529 plans have become a major option for those seeking higher education in the US thanks to its tax advantage.
529 plans are savings plans for parents who want to fund their child’s higher education with the help of the IRC or Internal Revenue Code.
There are two types of 529 plans which include prepaid tuition plans and educational savings plans.
How Do 529 Plans Work?
529 plans typically work by deferring the taxes from the interest earned from the savings account. Most of the time, 529 plans are established by parents or grandparents on behalf of their child.
They put in the funds and allow it to grow throughout the years until it is then used for college education. The person who funds the 529 plan will then be eligible for state tax deductions for the contributions that they’ve made.
The money grows as time goes by, and when it is time for them to use it for college funding, there are no taxes when they are withdrawn. Take note that tax benefits differ from state to state, so be sure to check the terms first.
What are the Types of 529 Plans?
As mentioned above, there are two types of 529 plans – the educational savings plan and the prepaid tuition plan. Educational savings plans are tax-free and often used for qualified education expenses.
The parent or donors usually start them for the beneficiary. Meanwhile, prepaid tuition plans are generally done before the beneficiary goes to college and has locked in the tuition fee as protection against the rising cost of college education.
The account holder then starts the plan and funds the account until it is ready for use when the beneficiary goes to college with the agreed-upon tuition fee.
What are the Upsides of 529 Plans
There are a lot of benefits to using 529 plans to fund your college education.
Many people might want to look at 529 plans as their option for college education funding instead of using student loans.
Here are some advantages you can benefit from when you choose to go with a 529 plan.
1. Tax-Free
One of the many reasons why people go for 529 plans is that they are not taxable. Withdrawals and the amount made through the savings fund are not taxable by the state, which is why people go for it.
You can use the amount that was supposed to be taxed by the state to add to your funds thus allowing you even more money to spend on your college education.
However, you still need to check the terms provided by your state to see if your contributions work to be sure.
2. Gift Tax Implications
You can also give a certain amount of money to an individual with a 529 plan and it is also non-taxable. In 2024, the annual gift tax exclusion was increased from $17,000 in 2023 to $18,000. This allows for more funds to be gifted to the account.
This also does not count against the lifetime gift tax implication. For example, anyone can give you enough funds for the year as part of their contribution to your college plan. The amount can be $90,000, which is $18,000 every year for five years.
As long as the contributor does not exceed the amount, you will get the total amount and it will also not be counted against their lifetime gift tax exemption.
3. Low Maintenance
When you have a 529 plan, you simply open the account through a licensed financial advisor and have the contributions linked to the account holder’s bank account.
They can then set up an automatic deduction from their account to the 529 plan every month. It is that simple. There is no need for you to go through several steps just to deposit the monthly amount into the account.
You can even choose to invest with the amount that you have so it can grow even further. By the time your child reaches college age, they have more funds to work with and you can sit back and relax.
4. Flexibility
One of the major reasons why people choose to have 529 plans is the flexibility. 529 plans are offered to all families regardless of their income or the amount that they want to contribute.
This means that everyone can contribute to the investment of a college fund without any discrimination. You can provide funds wherever you are and whichever child you wish to attend college.
Such flexibility allows parents to deposit whatever amount they wish to provide and allows them to choose which child they wish to support.
Downsides of 529 Plans
While there are a lot of upsides to getting 529 plans, there are also some downsides to it.
Check out some of the disadvantages that come with using a 529 plan down below.
1. Penalty for Non-Qualified Withdrawals
There will be instances that you’ll encounter non-qualified withdrawals which are then subjected to income tax.
This penalty can reach up to 10%, but it can be avoided if the beneficiary gets a scholarship or becomes disabled.
It is also applicable if the beneficiary attends a US Military Academy instead of a college.
2. Ownership
Account ownership is one of the significant downsides of having a 529 plan. As a beneficiary, you are under the account owner’s control, especially if it is a donor and not your parents.
The owner can easily change whoever they want to give the funds to, which is not what you want.
Conclusion
529 plans are the best option to fund your college expenses. If you’re willing to start now, your child can easily have the funding for their college education once they reach that age.
By understanding the upsides and downsides of 529 plans, you can decide whether you want to pursue this option or find other ways to find your child’s higher education.
