Researching and evaluating colleges can be daunting. There are numerous factors to compare, such as each school’s size, location, admission requirements, degree programs, placement rates, housing, and student activities. And then there’s the matter of tuition, which has been rising steadily along with the amount of student-loan debt.
Thankfully, 529 accounts (savings accounts specifically designed for education expenses) can help cover the cost of school as well as provide tax benefits to the account owner. There are several differences to consider though when choosing which plan is the best fit for your family.
To help, here’s a summary of the different types of 529 plans, common misconceptions about them, and which expenses qualify.
Types of Plans
When it comes to 529 accounts, you have the option of a prepaid tuition plan or a college saving plan. The benefit of a 529 prepaid tuition plan is that you lock in tuition at today’s rates at participating schools. The downside is that these plans typically have more restrictive requirements, such as:
- Must be a resident of the state
- Must make required installment payments
- Less flexibility for what counts as qualified education expenses
If you choose a prepaid tuition plan and your child goes to a different school, you can still use the account to pay for tuition; however, you won’t receive discounted tuition. For example, if your student decides to attend a private or out-of-state college instead, the plan typically pays the average of in-state public college tuition. Your family is responsible for the difference, if any. (Private College 529 Plans enable you to purchase tuition credits for any participating college or university.)
Despite the benefits 529 accounts offer, there often are misperceptions about these education savings plans. The questions and answers below clarify some of the most common areas of confusion:
Which expenses are considered qualified education expenses?
Can I change the beneficiary of a 529 plan?
Yes, you can change the beneficiary if there are excess funds in your 529 or if you (the account owner) want to change the beneficiary to another direct relative. You may do so at any time and it doesn’t require the use of a will.
What happens if my student receives a scholarship and doesn’t need the money in our 529 plan?
You can withdraw the same value as the scholarship amount without having to pay taxes or penalties on that withdrawal amount. Alternatively, you can redirect the excess funds to a new 529 beneficiary.
How will a 529 savings plan affect FASFA?
A parent’s 529 savings plan doesn’t hurt the student’s ability to receive financial aid. However, 50% of a withdrawal from a grandparent’s 529 savings plan counts towards a student’s income and can hurt his/her chances for financial aid the following year. Therefore, if you intend to fund a student’s education with multiple 529 savings plans, be sure to strategically plan for distributions so there isn’t a negative impact on your student’s future financial aid.
Also, there have been recent modifications to the Free Application for Federal Student Aid (FASFA) deadlines. Families can apply earlier and will receive universities’ aid packages sooner. Have patience when accepting a financial package from a university because, with these changes, your student should have more time to hear from different schools and more time to accept aid from the school he/she truly wants to attend.
What if you withdrawal money from a 529 for non-qualified expenses?
If you withdraw funds for a non-qualified expense, you’ll have to pay taxes on them as well as a 10% penalty on the earnings.
A Smart Move
In a nutshell, 529 plans are a great way to save for college. They offer many benefits to both parents and students, and Fidelity has excellent tips for stretching your 529 savings as far as possible.
If you’d like to know more about saving for future education costs or you’re interested in opening a 529 account, simply contact your Redwood advisor.
KELSEY BROOKS, CFP®