If you’re interested in this you’re probably a parent and looking to save for your kid’s future college fund and heard that a 529 is a great way to do it. That’s awesome and from what I can tell mostly true. Given how fast higher education costs are growing planning ahead is a good thing, but is it always the right time? Let’s dig in a bit more.
Should I open a 529?
First thing we need to look at is if the 529 is actually the right thing vehicle for you at this point. Generally speaking I’d consider the 529 after you’ve started contributing pretty heavily to (and hopefully are close to maxing out) your own retirement savings accounts (401k/IRAs as I’ve discussed before).
If the above isn’t true, I’d suggest starting with the more traditional retirement vehicles. Both options have similar preferential tax treatment, but the 529 is much more limited in its use.
What exactly is a 529 Plan?
Sweet so assuming you’re setting yourself up for retirement already let’s talk about 529s.
From the SEC’s website
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
States and 529s
Qualified Institute
An eligible educational institution is a school offering higher education beyond high school. It is any college, university, vocational school, or other post secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education.
This includes most accredited public, nonprofit and privately-owned–for-profit postsecondary institutions.
The best way to check is the ask the school and check online. Do both as some schools may not show up in the list online.
Qualified Expenses
- First up are any tuitions for the school
- Room and board also count, but it can’t exceed the room and board cost used when calculating financial aid (a.k.a how much the school would charge you for room and board on campus). Best to check with the school to find out the amount if the plan is to live off campus.
- Any required books for courses.
- Computers can be counted as a qualified expense as long as they are mainly used by the beneficiary during years that they are enrolled.
- Computer software is less clear, but if it’s required for class it counts. Pro-tip: check the campus store for education versions as they tend to be much cheaper too.
Not Qualified Expenses
- Transportation (even to/from school)
- Health Insurance (even university insurance)
- Sports or club fees
Flexible Beneficiary System
Yes. There are no tax consequences if you change the designated beneficiary to another member of the family. Also, any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family. So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty.
529 Drawbacks
- Note that 529s can only be used on higher education. You can’t use these funds for a private high school for example.
- If your student qualifies for financial aid 529s can also affect the amount they may get.
- There’s also some minor complexity as to how the 529 disbursements are counts depending on who the account owner is (generally this manifests as parents vs grandparents). More on that in a future post.
- If you take money out of it for a non-qualified expense there’s a 10% penalty on top of the regular income tax.
This is by no means a deep discussion of 529s, but I consider the above a decent starting point to understand how they work and decide if it’s something you should investigate further.
