The biggest misconceptions about using 529 plans to save for college
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529 plans — tax-advantaged investment vehicles designed to help families save for college — are often misunderstood.
As a result, many families risk missing out on an important savings opportunity. This is because savings from a 529 plan are exempt from federal income tax and withdrawals for qualifying expenses are tax exempt. Some states also offer similar tax benefits.
Here are six common misconceptions about these diets:
No. 1: Only parents can invest
People mistakenly believe that only parents can invest on behalf of a child, but that is not the case. Grandparents, aunts and uncles, or even someone unrelated, can open an account in a child’s name or contribute to that child’s account, said Rachel Biar, assistant state treasurer of Nebraska who chairs the College Savings Plans Network, a repository of information on 529 plans.
Family members might consider contributing to a 529 plan for a child instead of buying toys or other knick-knacks for birthdays and holidays. To make things easier, many 529s offer family and friends the ability to contribute to an account online, by mail or by phone, said Illinois State Treasurer Michael Frerichs.
Just keep in mind that for states that offer an income tax deduction or credit, the account holder is usually the one who can claim that benefit, Biar said.
No. 2: can only be used in a traditional four-year college
Chances are your child will need some type of post-high school education, and 529s can be used in a range of other schools and training beyond four-year colleges and universities. Notably, the funds must not be used in a public school.
In October 2021, 61.8% of high school graduates aged 16 to 24 were enrolled in colleges or universities, roughly on par with the figures from the previous year, according to Data from the US Bureau of Labor Statistics. Among recent high school graduates enrolled in college, seven in 10 have attended four-year colleges.
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Beyond four-year schools, 529 plan funds can also be used at eligible graduate schools, community colleges, two-year schools, vocational or technical schools, and certain apprenticeships. Families can use government online resources to determine if a school is considered an eligible educational institutionand to help students determine whether an apprenticeship program whoever interests them qualifies for 529 plans.
Funds from a 529 plan can also be used to pay off up to $10,000 in student loan debt.
No. 3: There is too much risk that the money will be wasted
If there is money left in the account, a family member of the current beneficiary can be named without tax consequences, said Mary Morris, managing director of Virginia529 and vice president of the College Savings Plans Network. The definition of a family member is broad and includes the beneficiary’s spouse, child, brother or sister-in-law, parents, aunts and uncles, nieces, nephews and first cousins. .
“It can go up and down the family tree,” Morris said. “You have a lot of flexibility.”
At worst, the owner can withdraw the funds and pay taxes and a 10% penalty on the income portion of the account, she added.
#4: It will ruin my family’s application for financial aid
Parent-owned 529 plans are treated more favorably than student-owned assets, so while there may be an impact on aid, it will be small compared to the savings potential, Biar said. “It’s not enough to discourage people from saving,” she said.
For parents who save more than the allocated $10,000 allowance, a maximum of 5.64% of parental assets will be counted, compared to a rate of 20% for student assets.
If the grandparents own the 529 account, it is not considered income to the recipient for financial assistance purposes until a withdrawal is made, Biar said. A workaround for students graduating in four years — based on how income is reported on the free federal student aid application — is to use money from the grandparent’s 529 account after Jan. 1. of the student’s second year of university. If the student plans to graduate in five years, the distribution can be made after January 1 of their junior year to avoid the financial aid impact.
N°5: It’s useless if my child gets a scholarship
Scholarships can help defer higher education costs, but a 529 plan can be used in conjunction with them.
Often, scholarships can only be used for tuition, while 529s can be used for books, room and board, and other eligible expenses, Biar said. Funds remaining in a 529 account will not be lost as another parent can be named beneficiary.
#6: Now is not the time to start saving for college
During market turmoil, people may worry that their investments will crash, or conversely, when the markets are doing particularly well, they may be nervous about buying too high.
The reality is that you can’t time the market and it’s always a good time to start saving, Frerichs said. There are several investment choices depending on risk tolerance and time horizon, and over time you can benefit from compounding income. Even ultra-conservative investors can participate. Some plans offer FDIC-insured options, for example.
“The best day to start saving for college is yesterday. The second best day to start saving for college is today,” Frerichs said.
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