College is one of the biggest expenses a family will face. As the nation’s total student loan debt tops $1.5 trillion, more parents are turning to 529 savings plans to help cover the costs. Here’s why:
1. Tax benefits
529 savings plans offer tax-free earnings growth and tax-free withdrawals when the funds are used to pay for college. A modest contribution of $100 a month can grow to over $37,000 in 18 years, assuming a 6 percent annual investment return. Thirty-four states and the District of Columbia also offer an additional tax deduction or credit for 529 plan contributions.
2. Favorable financial aid treatment
Funds held in a 529 plan owned by a parent or dependent student are considered a parental asset on the Free Application for Federal Student Aid (FAFSA). Only a maximum of 5.64 percent of parent savings are counted as available funds to pay for college, compared to 20 percent of other student-owned accounts. Qualified distributions from a 529 plan are also excluded from income reported on the FAFSA, as long as the account is owned by a parent or dependent student.
3. Flexibility
These plans can be used to pay for qualifying expenses at any eligible two-year, four-year, public or private college or university, vocational school and even some international schools. The Tax Cuts and Jobs Act of 2017 also allows tax-free withdrawals for K-12 tuition.
If you end up with leftover money in the account, you can change the beneficiary to a qualifying family member without tax consequences or save the money for future use. If you take a non-qualified withdrawal, the earnings portion will be subject to income tax as well as a 10 percent penalty (the penalty is waived in cases where the student gets a scholarship or attends a U.S. Military Academy).
4. Gifting
According to a 2017 Savingforcollege.com survey, 35 percent of parents hope 5 percent or more of their child’s college funds will come from gifts. Many 529 plans offer gifting platforms that make it easy friends and relatives to contribute.
There’s also been a growing interest in 529 plans among grandparents, especially those looking to reduce their taxable estate. A 529 plan contribution is considered a gift to the beneficiary and will qualify for the annual gift tax exclusion ($15,000 per beneficiary in 2018).
Almost every state now offers at least one 529 plan, and many are available nationwide. Check to see if your home state offers any benefits for residents and be sure to review the plan’s fees and investment options before you make a decision. The most important thing is to get started, since every dollar you’re able to save is one less your child will have to borrow.
Kathryn Flynn, Content Director, Savingforcollege.com, [email protected]