We'll discuss 5 questions you might have about 529 plans:
One of the most efficient ways to save for college is opening a 529 plan. A 529 is a state-sponsored investment plan that's specifically designed to save for higher education.
Similar to a Roth IRA, a 529 plan uses after-tax contributions that grow tax-deferred so that when you take the money out for college expenses later on, it's tax-free.
Like most investment accounts, there are some fine-print details to be aware of, and asking questions is always a smart idea. To help you better understand 529 plans, we put together a list of the most common questions that you might not necessarily think about until college is right around the corner. The answers may surprise you!
What happens if the child decides not to go to college?
Many people begin saving for college years in advance, just assuming their child will take the traditional college route. If that ends up not being the case for you, that doesn't mean your 529 investment was a waste of time. You'll have a couple of different options.
- It's not just for college. Up to $10,000 each year can be used for kindergarten through 12th grade tuition expenses. You can also use 529 money for community colleges, trade schools, and career-oriented certificate programs. If your child wants to take a gap year (or two), you can hang onto the 529 funds in case they do eventually warm up to the idea of college.
- You can share with a family member. If a child decides that college isn't for them, you can transfer the 529 college savings plan to another beneficiary who is related – including yourself if you've been wanting to get back in the classroom. Transfers can be done once per year, and the eligible family member list is pretty broad, including parents, grandparents, aunts, uncles, step-relatives, in-laws, children, spouses of the relatives mentioned above, and first cousins.
- You can withdraw the money and pay the penalty. No one likes to give the government extra money, but the 10% penalty you'll pay is just on the earnings portion of your 529 plan, not the amount you contributed. In other words, you may take a small hit, but you're still coming out ahead.
If my teen gets a full-ride scholarship, how can we use the 529 funds?
If you're in the fortunate position of your child earning a large college scholarship, there's some more good news. You can withdraw up to the amount of the scholarship award penalty free. So in other words, if the scholarship is worth $30,000, you can take out $30,000 from the 529 and use it for whatever you'd like without a penalty.
Will having a 529 reduce the amount of financial aid I get?
Any assets you or your child has do have an impact on financial aid eligibility, but a 529 isn't weighed as heavily as some other types of savings. That's because a 529 plan, whether it is owned by a dependent student or one of their parents, is counted as a parent asset in the FAFSA calculation. The first $10,000 or so won't be counted thanks to the Asset Protection Allowance, and the rest will reduce a student's aid package by up to 5.64% of the asset's value.
In other words, if you have $50,000 in a 529 and you qualify for the full $10,000 allowance, the most your aid could be reduced by is $2,256 ($40,000 x 5.64%).
Is it better to use a 529 all at once or over the four years?
Depending on your personal financial situation and which financial expert you speak to, you may get different advice on this. The first thing to understand is that you can use the 529 however you wish, and it will be penalty-free assuming it's for qualified education expenses. That said, there is an argument to be made for either option:
- Using it up right away. Withdrawing your 529 money up front could help you qualify for more financial aid later on since it will reduce your parent asset amount. However, if you have a high enough income, even that reduction may not help you qualify for additional financial aid. The other thing to consider is if you'll qualify for the American Opportunity Tax Credit (AOTC), which provides a tax credit of up to $2,500 when you spend $4,000 on tuition, fees, textbooks, and other course materials. If you are within the income threshold to qualify for AOTC, it pays to cash flow at least $4,000 of college expenses so you can get the tax break.
- Spreading it out evenly over each college year. One of the key benefits of keeping some money in the 529 longer is that it can continue to earn (though that's not a guarantee, as it's dependent on market conditions). However, spacing out your withdrawals can give you some peace of mind that you'll have some funds available just in case you are unable to qualify for loans later on for whatever reason.
Can I use the 529 plan to pay student loans?
In 2019, student loans were added as a qualified expense for 529 funds. You are limited to using just $10,000 toward repaying the beneficiary's student loans, including federal and most private loans. And, if your child has siblings, you can get an additional $10,000 toward each of their loans as well.
Have more questions?
If you have 529 accounts for your children and college is approaching, it's always a good idea to consult with your tax accountant and financial advisor to figure out the best way to maximize your funds.