New parents might wonder how they can afford college for their child. With tuition costs and student loan debt on the rise, parents should start preparing for their child’s future as soon as possible.
Enter the 529 college savings plan. It’s a program run by individual states to help parents grow their college savings fund over time.
“Everyone’s financial situation is different, but I think 529 plans are the best choice for saving for college,” said Andy Tapparo, president of Tapparo Capital Management.
While 529 plans are lauded by financial professionals as the best way to save, most parents don’t have them. A recent Policygenius survey revealed only one in five parents had a 529 college savings plan. So is this account the best way to save for college?
What is a 529 plan?
A 529 college savings plan is a tax-advantaged savings or investing account designed to help parents and other loved ones save for a child’s education.
There are two types of 529 plans: investment plans and prepaid tuition plans. Prepaid tuition plans allow parents to buy college credits at the current rate, which locks in the cost. Investment plans are more common and are like a regular investment portfolio with a mixture of stocks and bonds that grows over time.
Benefits of a 529 college savings plan
A 529 plan is generally considered a simple and convenient way to save. The main advantage is the tax-based savings, said Tapparo.
While contributions to a 529 plan aren’t exempt from federal taxation, the future earnings are tax-deferred and any withdrawals are tax-free, as long as you spend the money on educational purposes. This includes tuition, fees, books, computers, room and board, among other things. It does not cover things like health insurance or student loan payments.
Ideally, parents should start depositing money into a 529 plan when their child is a newborn, or even while they were pregnant. They shouldn’t withdraw until their child is ready to go to college.
“It defeats the purpose if you withdraw early,” said Kaleb Paddock, certified financial planner and founder of Ten Talents Financial Planning. “The whole point is growth.”
Why wouldn’t parents use a 529 plan?
Some 529 plans have high fees. But this negative can be remedied by finding a state that offers a lower-cost 529 plan.
“For example, the Utah 529 plan is run by Vanguard and offers low-expense options. You don’t even have to live in Utah to open an account in that state,” said Paddock. “You could live in California and open a Utah 529 account and then go to school in New York.”
Learn about state requirements and eligibility with our state-by-state guide to 529 plans.
Other parents may worry about saving money in a 529 plan, only to find out their child isn’t interested in attending college. But they can still access their 529 funds.
“If your child doesn’t use the funds, for whatever reason, you can name another immediate family member and use the money for their education costs,” said Paddock. “It’s also not like you can’t access the money at all. You can withdraw money for non-education purposes, but there are penalties.”
Looking to open a 529 savings account? Check out our guide here.
Image: Phillip Blackowl