There are a variety of ways you can save for college including 529 plans, Coverdell Education Savings Accounts, and UGMA/UTMA accounts. Although 529 plans are probably the most popular way to save for college, there are many misconceptions about how to use them. There are two types of 529 plans, 529 college savings plans and 529 prepaid plans. States, state agencies, and institutions are responsible for managing 529 plans, including creating guidelines and restrictions. This article will help you understand the core features of 529 plans and learn the most common misconceptions.
Myth 1: You Have to Invest in Your State’s 529 Plan
While some 529 prepaid plans are limited to residents of the state, most 529 college savings plans are open to residents of any state. Popular options nationwide include Utah’s My529 Plan and New York’s 529 Direct Plan. When shopping for a 529 plan, consider the features of the program, including fees and contribution limits. There are some benefits to choosing a plan in your state. For example, some states like Alabama, Utah, and New York only offer a tax deduction if you invest in the state 529 plan.
Myth 2: You Will Lose the Money if Your Child doesn’t Go to College or Earns a Scholarship
One of the most common misconceptions about 529 plans is that you will lose the money if your child doesn’t attend college. You have several options to avoid penalties including the following:
Change the beneficiary - You can change the beneficiary to an eligible family member, such as a parent, sibling, cousins, aunt, uncle, or even grandparent.
Use for K-12 education - Up to $10,000 per year can be used towards K-12 tuition. You can change the beneficiary to a younger child or relative to use for their education expenses.
Transfer to an ABLE plan - If the beneficiary or an eligible relative becomes disabled, you can transfer the money to an Achieving a Better Life Experience (ABLE) account, which can be used for qualified expenses.
Withdrawal - There is always the option to withdraw the money. There is a 10% penalty, and the earnings portion of the account will be subject to income tax. However, if the beneficiary earns a scholarship, attends military school, is disabled, or deceased, the owner can withdraw the money without penalty and pay the income tax online.
Myth 3: Opening a 529 Plan Will Negatively Impact Financial Aid
Many parents worry about how a 529 will impact their financial aid package. If a parent or a dependent student owns a 529 account, only 5.64% of the account’s value is assessed as part of the FAFSA. For example, if you have $100,000 in your 529 college savings plan, only $5,640 is counted towards your EFC (Expected Family Contribution) unlike the money in the UGMA/UTMA account that will be assessed at 20%, or $20,000, of the account’s value.
Myth 4: A 529 Plan is Only for Children
529 college savings plans are not only for young college-bound students. The truth is that anyone can open a 529 plan and even name themselves a beneficiary. For example, you may consider opening a 529 college savings plan after college to save for professional development and graduate education later in your career.
Myth 5: I Make too Much or too Little to Open a 529 Plan
There are no income limits for a 529 plan, and regardless of your income, a 529 plan is an opportunity to earn tax-free money for college. Some plans can be opened with as little as $25. Lifetime contribution maximums are set by each plan and range from $200,000 to $500,000, which is expected to cover the total cost of college.
Myth 6: You can Only Use the 529 Distribution in Your State or the State that Manages Your Plan
Most college savings plans can be used anywhere. For example, a resident of California can invest in a 529 plan in Utah, and use that money to attend college in Colorado. The truth is that most 529 college savings plans are quite flexible and can be used anywhere. Prepaid plans are typically restricted to a specific school or group of schools that participate in a given plan.
Myth 7: 529 Plans can Only be Used for Tuition
Most 529 prepaid plans can only be used for mandatory tuition and fees. However, if you use a 529 college savings plan to pay for expenses, you can use the distribution for tuition and mandatory fees, room and board (if you're enrolled at least half-time), books, required school supplies, and tech including computers, printers, and internet.
Myth 8: Only a Parent can Open a 529 Plan
Grandparents, aunts, uncles, and even friends can open a 529 for a beneficiary of their choice. Some states do have residency restrictions, so it’s important to be mindful of this if the beneficiary is in a different state.
A Final Word on 529 Plans
529 plans are an excellent way for most families and college students to save money for college and related expenses like room and board. It’s important to do your research on residency requirements, fees, and contribution limits to find out which plan is best for you. Ultimately, it’s best to consult a tax professional to maximize your contribution to your 529 plan.