Top 10 Reasons to Use a 529
Happy 5/29 Day! 529s are almost always the best way to save for college, yet only about 1/3 of families actually use them for college savings. In fact, a recent survey showed that only about half of American adults have heard of 529s. This is incredibly unfortunate because 529s are such a powerful tool in creating pathways to higher education. So in honor of 529 Day, here are my top 10 reasons you should open a 529 for your child's education.
Your child is more likely to get a college degree if you save. Numerous studies have shown that children whose families have saved for college not only enroll in college at higher rates, they also graduate from college at higher rates. This holds true even for small amounts of savings.
Tax benefits mean you'll have more money available for college. 529 plans have at least two, and often three, tax benefits: tax-free growth, tax-free distributions, and in many states a tax deduction or credit for distributions. Add those up and you may have 20-25% more money available for college by saving in a 529 rather than a taxable account.
529s get preferential treatment in financial aid formulas. Families eligible for need-based financial aid financial aid benefit several ways: sibling 529 accounts aren't reported on the FAFSA, and distributions from 529s are not included in income on your tax return, meaning they don't increase your Student Aid Index. And, since 529s are counted as a parent asset, they receive favorable treatment in the financial aid formula, with the FAFSA only including 5.64% of the student's 529 account balance in the SAI.
You have an actual budget for college. If you save in a dedicated account such as a 529, you know how much savings is available for college. Often families will mentally earmark other assets to pay for college-- a brokerage account or a Roth IRA for example-- but then when the time comes to pay for college, they don't have a clear sense of how much of that account can be used for college without compromising other financial priorities.
Investments help your savings keep up with the cost of college, and minimize risk as you get closer to college. Unfortunately, lots of families save for college in regular savings accounts, where the interest your money earns usually won't keep up with increases in college costs. 529 plans have their own version of target date funds, which allocate your investments in a risk-appropriate manner based on your child's age. That means the investments are more aggressive when your child is younger, and rebalance to reduce risk as college approaches. And best of all, all of that happens automatically.
Gifting pages let others help pay for college. Most 529s have a tool called a gifting page. This lets you share a link to your child's 529 with friends and family who are generous with your child and who might contribute to their education as well. If your state's plan doesn't offer a gifting page, you can always open an account in Utah's my529 plan just to use the gifting page.
529s can be used for a range of college expenses. Tuition and fees, of course. But 529s can also be used for room and board, both on- and off-campus. For off-campus housing, you'll want to check your school's allowance for off-campus room and board since that's the maximum amount you can withdraw from your 529 for room and board. But that's not all: 529s can be used for books, required supplies, lab fees, a computer, and internet access. And of course, tuition isn't just for four-year colleges; community college tuition, fees, books and supplies are also qualified expenses for 529s.
529s can be used for some non-college expenses, too. Those include trade and vocational schools, private K-12 tuition, and up to $10,000 of student loan debt. Note that not all states conform to these rules; it may be the case that these expenses are qualified on your federal tax return and non-qualified (meaning you'd pay tax on the earnings portion of the distribution) on your state tax return. And if you still have excess, you can change the beneficiary to another family member, or simply take a distribution and pay the tax and penalty (10%) on the earnings portion.
Excess 529 funds can be converted to Roth IRAs. As of this year, you can convert up to $35,000 of excess 529 funds to the beneficiary's Roth IRA, tax- and penalty-free. There are a few requirements, but if you have delayed setting up a 529 because you're not sure if your child will go to college, stop worrying about that and start thinking of a 529 as a launch fund, not just a college fund.
529s can be beneficial in estate and legacy planning. Money contributed to a 529 is removed from the donor's estate; superfunding, where you make five years worth of contributions in a single year, can be quite impactful in reducing estate tax liability. And once money goes into a 529, it can be passed down from generation to generation: if the original beneficiary doesn't use all of it, they can change the beneficiary to their own child, who can do the same for their children.
If you don't have a 529 yet, go and open one now. Not sure which one? If your state offers a tax break for contributions, use your state's plan. If not, use Utah's my529 plan. Choosing a 529 does not restrict your child's future college choice; you can use any 529 at any college where you can take out a federal student loan-- including four-year colleges, two-year colleges, and even some international colleges.
If you do have a 529, make sure you have an automatic monthly contribution going into it. If you've already set up a monthly contribution, check your budget and see if you can increase it. Even if you only increase it by $5 per month, over time that will make a difference in your child's college budget. And then don't forget to share the gifting link ahead of your child's birthday and other gift-giving occasions.
