By Team Tomorrow
Published September 13, 2021
529 accounts can be a parent’s new best friend.
A 529 plan is an investment account comparable to a Roth IRA or Roth 401(k) that offers tax benefits for qualified education expenses, including:
Unlike a custodial account, the owner of the 529 account maintains possession of the account until the money is withdrawn. As long as the money remains in the account, you don’t have to pay income taxes on the earnings. When you take money out for education-related expenses, they are usually both state tax and federal income tax-free. That all depends on the type of plan you have and what the rules are in your state or district.
Each 529 plan offers investment portfolios customized to your risk tolerance and time frame. Much like the stock market, your portfolio may increase or decrease in value based on how your investment performs. Saving For College has a tool that helps you compare plans to determine what works best for you.
The main types of 529 accounts fall into two categories: 529 savings plans and prepaid tuition plans.
With savings plans, the account holder contributes money and can choose the funds they want to invest in. 529 savings plans also offer target-date funds, which means your assets can grow in a way that is optimized for an allotted time frame (i.e. when your child starts going to college).
Prepaid tuition plans allow you to lock in future tuition costs at current rates, which circumvents college inflation. These plans are usually meant for pre-paying all or part of the costs of an in-state public college education. However, they can also be used at private and out-of-state colleges with a Private College 529, a prepaid plan sponsored by more than 300 private colleges.
The downside with prepaid tuition plans are their limitations. Unlike savings plans, they usually only cover tuition and fees. Money.com suggests that unless you’re positive your kids will end up going to a State U school, a traditional 529 savings account is a safer bet.
The assets in your 529 account are considered a parental asset on your FAFSA, but at a limited capacity. The first $10,000 saved isn’t counted as part of your Expected Family Contribution. For any amount after that, only a maximum of 5.64% is counted, compared to the 20% considered in other plans.
Here’s what this looks like:
|Expected Family Contribution (EFC): 529 Accounts vs. Other Plans|
|Amount Saved||EFC for 529 Account||EFC for Other Plans|
*The higher your EFC is, the less financial aid you and your child can qualify for.
If someone else owns the 529 account, like a grandparent, aunt, or wealthy friend, it won’t impact your FAFSA. However, it is counted as student income when they withdraw the funds to pay for your child’s education expenses. Student income is assessed at 50%. This means if a grandparent pays $10,000 of college costs, it reduces your child’s aid eligibility by $5,000.
You can avoid this by withdrawing these funds during your child’s last two years of school. The FAFSA looks at income from two years prior:
If your child doesn’t go to college, you will usually have to pay income tax and a penalty of the earnings portion when withdrawing funds, since it’s not for educational purposes. The penalty is waived when the following conditions:
If there’s money leftover in your 529 plan after your child completes their education, you have a few options:
Check out our guide to college financial planning to learn more and explore other options.
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