What Parents Need to Know About 529 Plans
According to educationdata.org, the cost of college in the United States grows at an annual rate of about 7%. 7 percent! If you have kids who are college bound, it’s good to be aware of all the ways to pay for college. With the right kind of planning, students (and their families) have the ability to earn a college degree without going into debt. Parents often rely on income, college savings accounts, investments, and student scholarships to cover the cost of college. Families with students who are applying to college should be sure to fill out the Free Application for Federal Student Aid (FAFSA) for federal financial aid; FAFSA includes aid in the form of grants, loans, and work-study programs. Loans are an option for some families too. For many college-bound kids, 529 plans are a piece of the financial puzzle. Read on for more about what parents need to know about 529 plans.
What are 529s?
Also known as Qualified Tuition Plans or QTPs, 529 plans are tax-advantaged education savings plans that are designed to encourage saving for future education costs. The two different types of plans include prepaid tuition plans and college savings plans.
Advantages of a 529 Plan
Saving for college seems like a win, and there are many pros to saving money in a 529. These include:
- Tax-free growth: Earning on 529 investments grow tax free.
- Tax-free withdrawals: Withdrawing money from a 529 to pay for qualified education expenses can be done tax-free.
- State tax breaks: Some states offer tax breaks on 529 contributions.
- Flexibility: 529s can be used on tuition, books, fees, and other approved expenses at eligible colleges and universities in the US. They can also be used for K-12 tuition. Unused 529s can be transferred to Roth IRAs.
Although saving for college is such a positive financial move, there are some drawbacks to putting all college savings into 529 plans. Some of these cons include:
- Penalties: Withdrawing money from a 529 early for non-qualified expenses can incur a penalty of around 10%.
- Fees: Some plans have high fees, which can affect the returns on your investment.
Expert advice about paying for college
Throughout the last decade, Shellee Howard of College Ready has helped many families send their students to college debt free. She has some interesting ideas about 529 plans and how they affect students’ EFCs—the expected family contribution. The EFC is a number calculated by the FAFSA. Based on income, assets, and the number of family members in college, the EFC is used to determine how much financial aid a student is expected to get. Students with lower EFCs may be more likely to receive grants or scholarships. According to Shellee, 529s can have adverse effects on EFC numbers. She notes, “The 529 plan is not a good plan for about 80% of the population. The changes coming to FAFSA this year can make the effects of 529s even worse.”
What are some of the changes coming to FAFSA this year?
- Grandparent contributions: In the 2023-24 school year, FAFSA will no longer require students to report cash support (such as grandparent-owned 529s) from grandparents. This change makes it easier for grandparents to help grandchildren save for college without affecting financial aid eligibility.
- IRS data: The FAFSA will begin to use IRS data to calculate families’ income and assets.
- Simplified income section: A simpler income section is aimed at helping students to complete the FAFSA more easily.
Isn’t college savings supposed to be a good thing?
Yes! And being debt free after college is ideal. Shellee Howard explains an interesting perspective on saving for college: “It’s like a tax code; if you know it, you save money and win the game of life. If you don’t know the codes, you better hire someone that does.” She goes on, “Like most things, knowledge saves you money. Unfortunately, the 529 appears to be the only option to many families. People don’t realize that big 529s can massively hurt scholarship opportunities.”
When it comes to college finances, seek professional advice.
The ins-and-outs of saving for college can be complicated. Working with a college financial planner is the best way to learn where your money is safe. College Ready students earned more than $5 million in scholarships—not loans to pay back—during the 2022-23 school year. Working with college financial planning professionals helps families and students learn how to lower their EFCs and help students to stand out.
Are you looking for guidance as your child starts the college application process? Reach out to College Ready to learn more.
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