Have you ever heard of a 529 Savings Plan before? If not, then you are in luck. I will share an overview of a 529 Savings Plan, and hopefully you will acquire the basic knowledge to see if this may be an option for you to add to your list of investments. So what is a 529 Savings Plan? According to IRS.gov, a 529 plan is “a plan operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training, or for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school for a designated beneficiary, such as a child or grandchild.”
There are two types of 529 Plans: 1) Prepaid Tuition Plan and 2) Savings Plan. The prepaid tuition plan is more restrictive and is used to purchase “tuition credits” for in-state public institutions. With this plan, you lock in current year tuition prices to pay for educational expenses in the future. For example, say your child is 8 years old now (in 2019), and you have identified a College or University in your state that you would like your child to attend when he/she reaches 18, with this plan, you prepay for tuition now, and then in 2029 (10 years from now), your child attends college for the price that you had essentially locked in during 2019. There are additional restrictions as well, as the prepaid tuition cannot be used to pay for room and board and some other non-tuition educational expenses. The Savings Plan is more common and less restrictive, and I will use the rest of this post to elaborate about this type of 529 Plan.
One of the common misconception is that 529 Savings Plans are only used to save for your children’s education. But the truth is, you can open a 529 Savings Plan for any relative, yourself, or even a friend. Just note that the funds used, should be used to pay for qualified educational expenses.
So how do you go about opening up a 529 Savings Plan? 529 Savings Plans are operated by the States. All 50 States plus the District of Columbia, has at least one 529 Savings Plan. It should be noted that you are not limited to open a 529 Savings Plan in the State in which you live. You have the freedom to open a 529 Savings Plan in any State, that is why it is important to compare the different plans offered by each State, and to see which one offers the best benefit for you. Collegesavings.org, offers a great comparison tool, and I recommend that you check it out. Once you have identified which 529 Savings Plan you would like to join, you can go to that specific 529 Savings Plan website and enroll to join. Please note that some 529 Savings Plan may require a minimum initial deposit, while others may not.
So how does the 529 Savings Plan work? First, you must note that you fund the plan with after tax dollars, meaning that you use money from your net pay. When you make your deposit, you can select from the list of investment choices offered by the plan. Please note that the investments are not FDIC insured, and hence, you could lose some or all of your initial investments, depending on the stock market conditions. Also, note that similar to retirement accounts, if the money is left in the account for long term, then you have a greater chance to have your balance grow and to rebound from any volatility in the stock market. The 529 Savings Plan in which you enroll, will list the available ways in which you can make a distribution once you are ready to use funds from the plan. You may be able to pay the educational institution directly from the plan, or you can reimburse yourself for any qualified educational equipment purchased (for example, a laptop/computer for school).
In the case that the person for whom you opened the 529 Savings Plan receives scholarships, then it should be noted that you can withdraw up to that equivalent amount from the 529 Savings Plan without the 10% IRS tax penalty. However, you will have to pay taxes on the earnings portion of your withdrawal. The IRS has the viewpoint that any withdrawal is a mix of principal and earnings. For example, say you have $10,000 in your 529 Savings Plan, and you or your beneficiary (person on the account), receives a scholarship of $5,000, then you can withdraw up to $5,000 from your 529 Savings Plan. You will have to pay taxes on the portion of this $5,000 that is deemed to be earnings.
On a final note, I wanted to share that you have the flexibility to assign a new beneficiary to the 529 Savings Plan as frequently as you would like, with no additional cost to you. Say for example, the beneficiary you had opened the Savings Plan for did not use all of the funds in the plan, then you can assign the plan to a new beneficiary, as long as the funds will be used to pay for qualified educational expenses. There is no age limit or time limit on owning a 529 Savings Plan. If your child was the beneficiary and did not use the funds in the plan, and your child is now an adult with their own children, then your grandchildren can now be assigned to the 529 Savings Plan as the new beneficiaries. This offers a great opportunity to build generational wealth/security through educational savings.
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