SAVING FOR COLLEGE USING A 529
- Logan Doup
- Nov 4, 2022
- 3 min read
How do I save for my kid’s future college expenses?
As Advisors, this is a common question that clients have for us. There are many ways to save for your child's future including 529s, ESAs, and UTMAs. For the purpose of this article, we will discuss what a 529 is as well as the advantages and disadvantages of using it to save for college expenses.
A 529 is a tax-advantaged savings plan which means the interest that is accumulated within the account grows tax-deferred and no income taxes are paid on the growth if the money is used for qualified educational expenses (please see below for a list of qualified expenses). The other tax advantage of this account is that the person responsible for funding the account may receive a deduction from their state taxes.
When the 529 was originally developed, it was for higher education only. This definition has since expanded and can now go towards K-12 schooling along with apprenticeship programs.
The benefit of using a 529 to pay for grades K-12
If you live in a state that offers a state deduction, you can fund the 529, get the tax deduction, and use those funds to pay for your child's private school tuition. If we were to take Ohio for example, Ohio allows an individual to deduct $4,000 per beneficiary per year. If you had two children and maximized the contributions that would be $8,000 you can deduct from your state income taxes. Ohio’s state income tax ranges from 2.765% - 3.990%. If you fell in the middle of that range, that would be 3.3775%. This saves you approximately $302 per year. Take that across the span of a child’s 13 years in school and you have a savings of almost $4,000.
Our President and Chief Investment Officer, John-Mark Young did a very informational video explaining how to get a tax benefit (if your state offers it) for using the 529 to pay for private school tuition for grades K-12. You can watch that video HERE.
Types of 529 plans
Educational Savings Plans
This is an account where the account holder contributes money to a plan and the money is then invested in the stock or bond market. Then, when the child starts college or a trade school, they can use the funds from the 529 to pay for their education.
Prepaid Tuition Plans
This is where an account holder can lock in current tuition rates for their future student.
Advantages of a 529
High contribution limits
This is helpful since the average cost of tuition for a 4-year public university is over $25,000/year and over $100,000 for a 4-year bachelor’s degree.
Flexible Plan Location: you can choose to have either an educational savings plan that is invested or prepaid college.
Easy to open and maintain
Tax-deferred growth
No income tax on the growth as long as the money is used for qualified expenses
State Tax deductions
Can be passed from one child to another
Disadvantages of a 529
Limited investment options
Fees vary per state
Restrictions with changing plans
Must be used for education (you pay a 10% penalty and taxes if you use the money in a 529 for non-qualified expenses)
Qualified Expenses:
College, graduate, or vocational school tuition and fees
Elementary or secondary school (K-12) tuition and fees
Books and school supplies
Student loan payments (up to $10,000)
Off-campus housing
Campus food and meal plans
Computers, Internet, and software used for schoolwork (student attendance required)
Special needs and accessibility equipment for students