How to Use a 529 Plan to Improve College Savings

by Thursday Bram · 7 comments

It used to be that saving for college was a relatively simple process: if you wanted to save for your child’s college education, you put money away wherever it was convenient. Now, though, there are several types of specific savings plans that offer you benefits that your old coffee can’t compare with. They may not be as convenient, but when your child is ready to start college, there will be more money available. Of these plans, a 529 plan offers some significant ways to improve on your college savings options.

Investment Plans Versus Savings Accounts

Saving for college in a savings account means that you’ll earn interest on any money you deposit. But, in the grand scheme of things, that interest won’t add up to much. 529 Savings Plans aren’t savings accounts, though, and they offer an opportunity to earn more money. They’re set up like 401(k)s or IRAs: the money you contribute to the plan is invested in mutual funds or similar investments. There is a risk, of course, that the value of those investments could go down between now and the date when your child is ready to start school, but most 529 plans do take conservative approaches to investing.

There is a second type of 529 plan that can pay off even more than an investment can. A 529 Prepaid Plan lets you pay for future college costs at today’s prices. Given the fact that the cost of college has far outpaced inflation and doesn’t look to be slowing down any time soon, taking that option could make for a pretty significant financial boost when your child is ready for school. Because 529 plans are operated by individual states, the prepaid tuition is usually set up to work with in-state schools. However, most plans do offer options for converting that money to be used at private and out-of-state colleges.

Automating Your Savings

Most 529 plans require that, in order to enroll, you have to set up an automatic monthly payment. Such a set up ensures that you’re actually contributing money to the account regularly, which isn’t true for many of other college savings options. You can, of course, contribute more with one-time payments, but having an automatic withdrawal set up makes the entire process easier. There’s an added benefit if you have a relative who wants to help contribute to the plan, as well: anyone can either make one-time payments or set up automatic withdrawals.

The Tax Benefits

Any contributions you make to a 529 plan grow tax-deferred and, as long as the money is used towards college expenses, withdrawals are tax-free. If that doesn’t make a big enough difference, many states offer additional tax benefits as well.

Not only can you create an automatic savings plan to put away money for your child’s education with a 529 plan, but you can increase that money and minimize the taxes you pay on it, all at the same time. It’s worth checking into the specifics of the plans offered in your state to find the best plan for your family.

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{ 7 comments… read them below or add one }

Vincent March 10, 2010 at 10:28 am

Not many people talk about the 529 plan even though it’s one of the best ways to keep more money for most households. Good information.

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Betsy March 10, 2010 at 12:31 pm

My kid’s 529 plan is setup and everything (state and federal) is tax free. With taxes no where to go but up, I’m going to be saving more and more as time goes by.

None of my friends have 529 plans either, and they all think college for their kids is too far down the road. Maybe they are hoping that their children will get full scholarship, or that they aren’t going to pay for it when the time comes. Otherwise, they will be sorry.

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marci March 10, 2010 at 12:53 pm

Shop around tho for low annual fees…. some of them charge more than others on the fees.

And yes, you can set them up for grandkids also :)

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Cd Phi March 10, 2010 at 12:55 pm

Growing up, I wish I would’ve read these financial blogs earlier because putting my college funds in a 529 would’ve generated so much more interest than a traditional savings account. I’m telling all my cousins who are starting to have babies to really take advantage of the 529 college fund. I’m sure you’ll be starting soon enough for baby Sara too right?

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WR March 10, 2010 at 2:35 pm

We setup 529’s the year our kids were born. Many plans offer age-based or target year based funds. These funds are initially stock-heavy and become more conservative as the target date approaches.

Tax bennies are huge depending on your state. check it out:
http://www.finaid.org/savings/state529deductions.phtml

One thing to keep in mind is that your kids can (and should) participate in funding their own college. They should write a check (from their own account) and mail it to the fund holder.

You should put the fund in your name as the “owner” (not the child, they are the beneficiary). Apparently lots of people get this backwards.

People are fearful that by having a fund like this it will remove their child’s chances for financial aid. This is not the case as this asset is not counted for that purpose when the Parent is the owner.

If you are not thrilled with the (rather moderate) returns these funds generate, you can use your IRA to pay for college.

One other option is to open a ROTH IRA for them. They can do this at any age and just need to earn income. They can stuff up to 5K per year and have lots of options for investing. (My pat advice is 40% in an Extended Market Index fund, 20% in a REIT Index- 20% in Bond Index and 20% in Int’l Index and move it to 60+ % Bonds while taking money out). Remember that with a ROTH they can take it out any time for any reason and since they are kids their income would probably not qualify for the tax deduction of a traditional IRA.

The only potential issue with this approach would be their assets at Financial Aid time. Not sure how a Roth IRA would compute.

If this seems complicated, just get a 529 :)

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Jamel Rose March 10, 2010 at 10:20 pm

If you use the funds for non-college-related purposes, you will owe taxes and penalties. The tax advantage of a 529 plan, which includes tax-free withdrawals for college tuition (and in some cases other college expenses), makes this savings plan more inviting than a regular savings account.

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WR March 11, 2010 at 6:20 am

Remember that you can set one up for yourself or your spouse if you are planning to take classes, even as an adult. There is no contribution limit and if it is within your state, most times there are tax benefits.

What other benefit do you get when you take just one class at your local school?
A free gym & pool pass? Student Discounts on software? (www.studica.com) . Maybe even learn a few things :)

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