There are many ways to save money for college. For many people, a 529 plan is one of the best ways to save money for higher education. A 529 plan gives you tax benefits if you use the money to pay for qualified education expenses for a specific beneficiary. Using your 529 plan, you can save for college, pay for K-12 tuition, and pay off student loans.
If you use a 529 plan to save for college education, your savings will not have much effect on your eligibility for financial aid. Here we’ll break down why you should consider a 529 plan and what you can expect when you get started.
529 Plan Tax Benefits
529 plans work just like a traditional 401(k) or a Roth IRA, but your money is invested in mutual funds and other investments that grow tax-deferred. Moreover, you can withdraw the money tax-free to pay for qualified college education expenses.
Contributions to a 529 college savings plan are not deductible under the federal income tax law, but many states offer state tax benefits to participants. You may qualify for a state tax deduction or a state tax credit, depending on where you live. There are more than 30 states that allow state taxpayers to deduct state income taxes or claim tax credits for contributing to a 529 college savings plan. Contributions made to a 529 college savings plan are worth more than traditional investment accounts or savings accounts.
Some families may use 529 plans as a way to plan their estates because contributions to the plans are treated as fully paid gifts to the beneficiaries. Up to $16,000 per donor per beneficiary is eligible for the annual gift tax deduction.
Advantages of 529 Plans
There are three common types of specialized college education savings accounts: 529 plans, prepaid plans, and Coverdell education savings accounts. 529 plans are often the most beneficial because they combine both tax and financial aid benefits. Some of the main advantages of 529 plans include:
- Favorable tax treatment: Contributions to 529 plans are made using the money you earned after you earned it, much like a Roth IRA or a 401(k). But unlike a Roth IRA, many states provide a tax benefit for state residents who make contributions to these plans. Earnings from a 529 plan are tax-deferred for many years and are tax-free if used to pay for qualified education expenses.
- Generous contribution limits: 529 plans provide special benefits, such as super-funding, which allows parents to make five years of contributions at once. In addition, the plans have no income restrictions.
- Favorable financial aid treatment: If a 529 plan is held by a dependent student or the student’s parent, the asset is reported as the parent’s financial asset on the FAFSA; any income from the plan is ignored. As a parent’s asset, a 529 plan is less detrimental to financial aid qualification than student assets, which reduces eligibility for need-based aid by 20% of the asset’s value.
Start Enjoying the Benefits of Your 529 Plan
Most states offer at least one type of 529 college savings plan sold directly by the state or through financial advisors. 529 plans help students save money for college, but they also help families pay up to $10,000 each year in K-12 tuition and allow borrowers to repay up to $10,000 (lifetime limit) on student loans. Regardless of the tax benefits your state offers, a 529 savings plan is a great way to save for education. Reach out to your CPA or financial advisor to learn how to get started on your 529 plan.