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A 529 plan is designed to help you save for a child or family member’s higher education expenses. These plans are administered and managed at the state level, so some aspects can vary by state, but they all serve the same purpose. There are two 529 plan options: prepaid and savings. Prepaid 529 plans essentially let you pay for future tuition at today’s price, and 529 savings plans, which are more common, work similarly to retirement savings accounts like IRAs.
Here are three reasons every parent should consider a 529 plan.
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1. There are tax benefits
You make after-tax contributions to a 529 plan, but unlike with a regular brokerage account, your investments get to grow and compound tax deferred. Contributions to a 529 plan aren’t tax-deductible federally, but some states allow for deductions. For example, North Carolina doesn’t allow deductions, South Carolina allows you to deduct the full amount of your contribution, and Georgia allows deductions of up to $4,000 ($8,000 if joint beneficiary).
In addition to your investments growing tax deferred, you also get to take tax-free withdrawals from a 529 plan for qualified education expenses, such as tuition, housing, computer and software, books, and meal plans. If you plan to send your kids to private school during K-12, you can also use 529 plan expenses for tuition (up to $10,000).
If you’re saving for your child’s tuition, you might as well do it in an account with tax advantages. Having your money compound tax deferred with tax-free withdrawals can easily save you thousands in taxes.
2. They have high contribution limits
Unlike Coverdell education savings accounts — which have $2,000 contribution limits — 529 plans don’t have annual contribution limits. They do, however, have aggregate contribution limits ranging from a couple hundred thousand to over half a million, depending on your state. The aggregate contribution limit is how much you can contribute total to a plan, but there’s nothing dictating how much you can contribute annually.
If your goal is to contribute $100,000, you can do $10,000 for 10 years or $25,000 in four years; the choice is all yours and relative to your means. Once you’ve contributed your state’s aggregate contribution limit, you can no longer contribute to the account, but it’ll continue earning money. If you have multiple kids, these high contribution limits can be a major benefit.
3. You don’t need to be an experienced investor
Although the money in 529 plans is being invested, you don’t need to be an experienced investor to have a good portfolio that provides good returns over the long run. If you’d prefer to just set your investments and not have to worry about it, you can elect into one of your plan’s age-based funds. These funds reallocate as time passes, becoming more conservative as your child nears college age. Since stocks are higher risk, higher reward, the fund will be stock heavy early on for growth and then shift to “safer” investments to focus on preserving what you’ve earned.
Age-based funds tend to have higher fees because they’re actively managed, but if you’re on board with the “set it and forget it” method, it could very well be worth it.
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