529 Plans & Other Ways to Save for College

Information and Expert Tips on Maximizing Your College Savings Potential

Running the numbers through a college savings calculator can be a sobering experience for parents, especially if multiple children are approaching high school graduation. According to a 2018 College Savings Indicator Study by Fidelity Investments, only 28 percent of parents are on track to reach their savings goal, and fewer parents are actively saving for college than they were in 2016. On top of that, parental understanding of college savings strategies remains surprisingly lacking, with less than a third of parents aware of available tax-advantaged education savings programs. This guide aims to remedy that, wherever you stand in the college savings game. Keep reading to get information on 529 plans and other savings options so your child can achieve their future higher education goals.

What is a 529 Plan?

One of the best ways to help save for higher education expenses is through the use of a 529 plan. 529 plans are tax-advantaged accounts specifically designed for paying college expenses. They allow the account holder to invest in any state’s plan and the beneficiary to use the funds at nearly any accredited higher educational institution in the country.

There are two primary types of 529 savings plans: 529 Education Savings Plans and 529 Prepaid Tuition Plans. Most states and the District of Columbia offer at least one type of 529 plan. The exception is Wyoming, which currently does not offer a 529 option. Although most plans follow the same general outline, there are variations in plans from one state to another. It is important, therefore, to compare all plans offered by a person’s home state, as well as by other states, in order to determine which is best for a prospective student’s specific college funding needs and educational goals.

Prepaid Tuition Plans vs. Education Savings Plans

Education Savings Plans

529 Education Savings Plans are similar to IRA or 401(k) retirement savings plans in that the funds in the account can be invested in a variety of different financial vehicles. Account values will rise and fall based on the performance of the underlying investments within the plan. There are two basic types of college savings plans: Direct and Advisor. Direct plans allow account owners to pick and choose how the funds are invested, whereas advisor plans employ financial firms to pick the contents of the plan’s portfolio. Normally, money contributions are invested in large, widely-held mutual funds, with the account owner able to pick from among two or more portfolio mix options. In most cases, portfolio mixes are age-based, that is, they start out with higher-risk, higher-return stocks, and are slowly converted to less risky bond and cash heavy mixes as the student reaches college age.

529 Education Savings Plans typically come with a number of fees, such as advisor fees, program management and administration fees, and underlying investment fees. The total fee costs of plans can vary significantly and should be weighed against benefits when comparing different plans and options.

Prepaid Tuition Plans

Prepaid tuition plans allow for the prepayment of part or all of the future costs of an in-state public college. They may be either state- or institution-sponsored. There is also currently one private, not-for-profit prepaid tuition plan available. In addition to the tax benefits similar to those of education savings plans, the major benefit of prepaid tuition plans is that they are not subject to market volatility. That’s because credits purchased through a prepaid tuition plan today can be redeemed years later when the beneficiary is off to college, with the same value power as when they were purchased.

The downside, however, is that prepaid tuition plans often have less flexibility when it comes to qualified education expenses compared to education savings plans. Funds are typically limited to tuition costs and mandatory fees. Terms vary, sometimes significantly, from plan to plan, so be sure to read a plan’s contract carefully before investing.

10 Benefits of a 529 Plan

  • You get a tax break
    Although contributions to a 529 plan are not tax deductible — meaning you won’t receive any federal discounts for having a 529 account — funds can grow on a tax-deferred basis. In fact, when it’s time to use account funds, they are often completely federal tax-free as long as they are used for qualified education expenses. Similarly, most states offer tax-deferred growth and tax-free withdrawals for qualified expenses.
  • Many things count as a “qualified education expense”
    To qualify for federal tax-free use of a 529 plan, the funds within the account must be utilized for what are considered qualified education expenses. Although these vary slightly by state, qualified education expenses usually include tuition, textbooks, computers, occasionally some room and board costs, and other academic supplies as long as they are used by the beneficiary.
  • Contributions are considered gifts
    It’s important to note here that contributions to 529 plans are considered gifts so are not taxed. For tax year 2018, the gift tax exemption for individuals is $15,000 ($30,000 per couple), so contributions to a 529 plan within that amount are not subject to taxation. During the first year of a 529 plan, however, up to five times the amount of the gift tax limit – or $75,000 for 2018 ($15,000 x 5) – may be contributed and treated as if the contribution were made over a five-year time period for gift tax purposes.
  • Anyone can contribute to a 529
    To make investing in future education easier, anyone is capable of contributing funds to a 529 plan. This means that grandparents, aunts, uncles and family friends and can make direct contributions to a 529 plan whenever it is convenient for them. For divorced couples, this often makes jointly investing in their child’s education an easier process.
  • There’s minimal impact on financial aid eligibility
    529 account holders can still complete a FAFSA form, as the funds within the account have a relatively small impact on aid eligibility. As 529 plans are considered parental assets, the maximum amount factored into the federal financial aid equation is 5.6 percent. This means that only a small percentage of the plan’s assets are included in the Expected Family Contribution used to determine the amount of aid families receive.
  • The named beneficiary can be changed
    There are many reasons a person may wish to change the named beneficiary on a 529 account — the beneficiary doesn’t want to attend college, perhaps not all of the funds in the account were needed and the account holder would like to transfer it to another child, or maybe the account was started before the beneficiary was born. Regardless of the purpose, the beneficiary can be transferred; however, there may be associated penalties to do so from the plan provider and state as well.
  • There are also state tax incentives
    Although 529 plans are not federally tax-deductible, most states offer a tax incentive for starting a 529 program, whether it be a deduction or or tax credit. These benefits are often awarded to in-state residents who are choosing to invest in their home state. Currently, more than 30 states offer an incentive for opening a 529 plan.
  • The person who opened the account controls the account
    529 plans remain under the control of the person who established the account, not the beneficiary, at all times. Therefore, the account owner is the decision-maker for how the money is invested, when and how it is withdrawn, and for what it is used. Unlike other forms of college savings accounts, the beneficiary does not directly receive 529 funds when they reach a certain age. Funds, however, must be used entirely for the beneficiary’s education and related costs.
  • 529s have low minimum and high maximum limits
    Maximum contribution limits are plan-specific, but most allow total contributions of $300,000 to $400,000. At the other end of the spectrum, most plans often have minimum contribution requirements as low as $25 to $50 per month, however this is regulated by state and other factors.
  • Funds can be used at most higher education institutions
    529 plans are flexible in regard to where the funds can be used. In most cases, funds can be used at colleges and universities, even trade schools, throughout the U.S. (and sometimes overseas), regardless of the specific plan or state in which the account originates. Terms of plans do differ, though, so potential investors are well-advised to pay careful attention to the details of a plan before signing up.

How to Open a 529 Plan

While the process to opening a 529 plan may differ slightly depending on type of plan and state, this section provides the basic step-by-step instructions for the majority of programs. Beginners can use this reference as a general guide to starting out, but should investigate what state-specific requirements may be relevant to them.

STEP 1

Choose a state

The first hurdle to clear when opening a 529 plan is to decide which state to do business in. Parents and contributors are not limited to selecting their resident state as a plan provider so can explore other options before signing on the dotted line. As each state individually determines its regulations regarding 529 savings plans, prospective investors should compare tax incentives, minimum contributions, account fees and investment options to find the best state and plan for their situation. While account holders have the freedom to choose in- or out-of-state, the majority of states offer a tax benefit to in-state investors.

STEP 2

Choose the type of 529 plan

Once a state has been pinpointed, account holders can now focus on what type of plan to choose. As discussed, two plan types exist, the 529 education savings plan or the 529 prepaid tuition plan, and there are benefits to both. Prepaid tuition plans are currently offered in less than 20 states and half of those require residency in order to apply. Education savings plans, on the other hand, are far more abundant and can be utilized for more flexible academic spending (prepaid plans are regulated to tuition costs and fees). 529 education savings plans offer many different investment strategies and are more resilient to market changes than most prepaid plans. But investors have unique needs and situations — some may be looking for the most straightforward and cheapest option while others may be savvy investors and want something more sophisticated. It is important to carefully choose an option based on your goals and financial situation.

STEP 3

Complete an application

Once an account holder has decided on the ideal 529 plan for their situation, the next step is applying. How and when to apply will be dependant on the chosen plan. For those intending to start a prepaid tuition plan, it’s crucial to know when the open enrollment period is for their program and complete the state-specific application on time. Those ready to start their 529 education savings plan should be prepared with their financial and beneficiary information and can start the application online.

STEP 4

Make a contribution

The next step is to start making contributions. This step is highly dependent on the parent or guardian’s financial situation and the amount they are capable of contributing. It also depends on where and in what plan they are investing. Some states do not have a minimum monthly contribution requirement, while others have minimums ranging from $15 to $50, and in some cases, even higher. In addition to any minimum monthly contribution requirement, plan contributors are also able to make large, lump sum deposits.

STEP 5

Choose your investments

Choosing your investments can feel like a daunting task, especially for those who are not so stock market savvy. As always, there is risk involved when investing and depending on the individual, a person may choose greater or less risk investments, and this also determines the potential your savings has to grow. Generally, investors choose greater risks, like investing in equities, when they are starting out and less risks, such as bonds and other fixed-income options, as they prepare to use the funds. Financial aid expert Mark Kantrowitz of savingforcollege.com offers insights into 529 investment strategies in the following sections.

529 Plans by State

STATEPLAN NAME(S)
AlabamaCollegeCounts 529
CollegeCounts 529 Advisor Plan
AlaskaJohn Hancock Freedom 529
T. Rowe Price College Savings Plan
University of Alaska College Savings Plan
ArizonaCollege Savings Bank 529 Plans
Fidelity Arizona College Savings Plan
Ivy Funds InvestEd 529 Plan
ArkansasGIFT College Investing PlaniShares 529 Plan
CaliforniaScholarShare College Savings Plan
ColoradoCollegeInvest Direct Portfolio College Savings Plan
CollegeInvest Scholar’s Choice College Savings Plan
CollegeInvest Smart Choice College Savings Plan
CollegeInvest Stable Value Plus College Savings Plan
ConnecticutCHET 529 College Savings Program
CHET Advisor College Savings Program
DelawareDelaware College Investment Plan
District of ColumbiaDC College Savings Plan
FloridaFlorida Prepaid College Board Plans (College Savings and Prepaid Plans)
GeorgiaPath2College 529 Plan
HawaiiHI 529 College Savings Plan
IdahoIDeal Idaho College Savings Plan
IllinoisBright Directions 529 Plan
Bright Start College Savings Plan
Bright Start Advisor College Savings Plan
College Illinois Prepaid Tuition Plan
IndianaCollege Choice 529 Direct Savings Plan
College Choice Advisor Savings Plan
College Choice CD Savings Plan
IowaCollege Savings Iowa 529 PlanIAdvisor 529
KansasLearningQuest 529 Education Savings Plan (Direct and Advisor)
Schwab 529 Savings Plan
KentuckyKentucky Affordable Prepaid Tuition
Kentucky Education Savings Plan Trust
LouisianaSTART Saving for College
MaineNextGen College Investing Plans (Direct and Select)
MarylandCollege Savings Plans of Maryland (Savings and Prepaid Tuition)
MassachusettsUFund Massachusetts 529 Plan
UPlan Prepaid Tuition Plan
MichiganMI 529 Advisor
Michigan Education Savings Program
Michigan Education Trust
MinnesotaMinnesota College Savings Program
MississippiMississippi Affordable College Savings Program
Mississippi Affordable College Tuition Plan
MissouriMOST 529 College Savings Plan
MontanaAchieve Montana
NebraskaNebraska 529 College Savings
Nebraska NEST Advisor Plan
State Farm 529 Savings Plan
T.D. Ameritrade 529 College Savings Plan
NevadaNevada Prepaid Tuition Program
Putnam 529 for America
SSGA UPromise 529
USAA 529 Plan
Vanguard 529 Plan
New HampshireFidelity 529 Advisor Savings Plan
Fidelity Unique College Investing Plan
New JerseyFranklin Templeton 529 College Plans
NJBEST 529 College Savings Plan
New MexicoScholar’s Edge 529
The Education Plan (Direct)
New YorkNew York’s 529 Advisor Guided College Savings Program
NY’S 529 College Savings Program
North CarolinaNC 529 Plan
North DakotaCollege SAVE
OhioBlackRock CollegeAdvantage 529 Plan
Ohio Tuition Trust AuthorityCollegeAdvantage 529 Plan
OklahomaOklahoma 529 College Savings Plan
OklahomaDream 529
OregonMFS Oregon 529 Plan
Oregon College Savings Plan
PennsylvaniaPA529
Rhode IslandCollegeBound 529 and CollegeBound Saver
South CarolinaFuture Scholar 529 College Savings Plan (Direct and Advisor)
South Carolina Tuition Prepayment Plan
South DakotaCollegeAccess 529 (Direct and Advisor)
TennesseeTennessee BEST Prepaid Plan
TNStars College Savings 529 Program
TexasLoneStar 529 Plan
Texas College Savings Plan
Texas Guaranteed Tuition Plan
Texas Tuition Promise Fund (Prepaid)
Utahmy529
VermontVermont Higher Education Investment Plan
VirginiaVirginia529 CollegeAmerica
Virginia529 CollegeWealth
Virginia529 inVest529
Virginia529 Prepaid529
WashingtonGuaranteed Education Tuition
West VirginiaSMART529 College Savings Plans (Direct, Select and Hartford)
WisconsinEdVest College Savings Plan
Voya Tomorrow’s Scholar 529 Plan
WyomingVirginia529 (open to WY residents; no in-state 529 program currently offered)

Things to Keep in Mind About 529s

Starting any savings plan is a long-term commitment so there are things you should consider, such as penalties and restrictions, before opening a 529 plan. Other things to keep in mind include:

Potential gift tax penalty

Individuals are eligible to contribute $75,000 gift-tax free to a 529 plan in a single year, while couples can contribute $150,000 tax-free. Although this may not apply to the broad, middle class population, a gift tax penalty, or recapture, may be imposed on contributions under two conditions: if an individual or couple makes any additional contributions greater than the maximum gift tax limits within five years, or if the contributor passes away before the five-year period has expired.

Account fees

All 529 savings plans have associated fees such as maintenance and enrollment, however some plans incur higher (and more fees) for different services. For example, investors opting for an advisor savings plan purchased through a financial agency should be aware that these plans generally have a higher upfront cost than buying plans directly through a state provider. All plan fees and their resulting impact should be considered before making a selection.

Restrictions and penalties

Just as qualified education expenses are tax-free, using 529 funds for any non-qualified expense is subject to income taxes and also to a 10 percent federal penalty. It is relevant to consider and understand all of the conditions in which 529 funds can be used so that families avoid improper spending and related penalties later on. Federal penalties also exist for overdrawing funds and, coincidentally, for under-using account funds.

Available time to save

Another important thing to consider is how much time you have to save before needing to use your 529 funds. This matters because it affects your investment strategy and by extension, which plan you may choose to begin with. As with most savings accounts, starting earlier is best, however that isn’t always an option for everyone. Analyzing different investment tactics and their outcomes for your specific situation can be a game-changer.

Involved risks

While investing in a 529 plan is much more reliable than “putting it all on black” at a casino, there are still related risk outcomes. For example, either due to external or internal forces, it’s a possibility that you don’t meet your target savings goal and have to rely on alternative means to help pay for college expenses. To avoid this scenario, account holders and contributors should monitor the progress of their 529 plan and make any necessary adjustments along the way.

Other Ways to Save for College

While 529 plans are considered the most popular and, for many, the first choice in saving for a college education, they are far from the only choice. Below are four other common options to effectively save for college. They may be considered as alternatives to 529 plans or used in combination with them to optimize savings efficiency.

  • Coverdell Education Savings Accounts
    A Coverdell Education Savings Account (or Coverdell ESA) is another tax-advantaged account designed to encourage saving for education. Like 529 plans, Coverdell ESAs allow tax-deferred growth of funds and tax-free withdrawals for qualified education purposes. Unlike 529 plans, funds in a Coverdell ESA can be used for qualified elementary and secondary school expenses, as well as for college. Contributions are limited to $2,000 per year.
  • U.S. Government Bonds
    Government bonds, particularly U.S. Savings Bonds, can be utilized for college savings and provide a safe investment with modest returns. The U.S. Treasury’s Education Bond Program permits qualified taxpayers to exclude from their gross income all or a portion of the interest earned on the redemption of eligible Series EE and Series I bonds. Proceeds must be used to pay for tuition and other educational expenses incurred at certain postsecondary institutions in order for the income exclusion to apply. Income limitations may also apply.
  • UGMA/UTMA Custodial Accounts
    UGMA and UTMA accounts are custodial accounts that allow individuals to donate financial gifts to minors for many purposes, including higher education expenses. Accounts are set up in the child/beneficiary’s name. Transfers into the account are permanent, but the custodian maintains control of the account until the beneficiary reaches maturity and ownership transfers to him or her. UGMA and UTMA accounts benefit the contributor, primarily in regard to estate taxes, but they may have a significant negative effect on the child/beneficiary’s ability to obtain college financial aid.
  • Roth IRAs
    A Roth IRA is a tax-advantaged individual retirement account than can, under the right circumstances, be used to fund a college education. The major advantages to using a Roth IRA to pay for college are: 1) Distributions from the account can be withdrawn for any purpose, including paying for a child’s college expenses, 100 percent tax and penalty free as long as the distributions are made after the account holder turns 59.5 years of age (and the holder has had an IRA for more than five years); 2) The contents of the Roth IRA are not counted toward the student’s Expected Family Contribution when determining eligibility for other financial aid; and 3) Account funds not used for education may be used by the holder for retirement purposes without unwanted tax problems.

10 Expert Tips on How to Save for College

Mark Kantrowitz is a best-selling financial author, with books discussing financial aid, saving for college strategies, and student loans. His career and experience as publisher and VP in research at Savingforcollege.com has made him one of the most sought out experts in financing higher education. Mr. Kantrowitz offered the following tips on saving for college:

  • Start as early as possible
    “Time is your greatest asset. The sooner you start, the more time you have for your earnings to compound,” Kantrowitz says. “Start saving as soon as possible, when the child is born; in fact, start saving before the child is born.” Parents and guardians can get a jumpstart on saving for future education by opening a taxable savings account and transferring those funds to a 529 plan later on, or simply by opening a 529 plan with the account holder listed as the beneficiary and later change the beneficiary to the child.
  • Set-up automatic payments
    “How do you go about saving? The first thing you need to do is make it automatic so you don’t have to take an action every single month in order to save,” Kantrowitz explains. People often forget to make a contribution or may spend the money for other purposes if it is not automatically withdrawn. “Every 529 plan has an automatic payment option. Some even have payroll deductions for participating employers. The minimum that you need to contribute per month in order to be signed-up for automatic investment is around $25.”
  • Save what you can
    “Every dollar saved is a dollar less you’re going to have to borrow. And college savings plans are the anecdote to student loan debt. If you were to save one dollar per day you would accumulate, between the interest and the contributions, about $10,000 by the time the child enrolls in college,” Kantrowitz stated. In addition, it’s wise for parents to deposit lump sums from tax returns, work bonuses or other monetary surpluses into their child’s 529 account when and if it is feasible.
  • Incrementally increase your contribution amount
    “Ideally, your college savings goal should be to save a third of the future college cost. When we break it up into monthly amounts it’s more attainable. Some people can’t afford $250 per month; you start low and gradually increase it,” Kantrowitz recommended reallocating old expenses, such as diaper costs, to increase monthly contributions to 529 plans and to make more mindful decisions when spending.
  • The market fluctuates; learn to manage risks
    “You can’t avoid the potential for losses, what you can do is manage it and that’s why age-based asset allocations are a good choice. Even if you have a big loss at the beginning, you have 17 years to recover. ” According to Kantrowitz, choosing an age-based asset allocation plan allows account holders to take greater investment risks earlier in the savings process, giving investors plenty of time to bounce back and regrow funds after any economic downturns.
  • Follow an age-based asset allocation strategy
    “Within the 529 plans you have a bunch of different investment opportunities, what I recommend is that you do an age-based asset allocation. It starts off aggressive and as the child gets closer to college, you should shift to a more conservative mix of investments,” said Kantrowitz. Ideally, account holders begin by investing 80 to 100 percent of funds in equities, greater gain and greater loss investments, and gradually reduce that percentage to around 20 percent as the child nears college. This way, if the market drops, the risk of large profit loss right before it’s time to pay for college is less.
  • Choose the lowest account fee plan for young beneficiaries
    When deciding which type of plan to buy — a plan with the lowest fees or a plan with the best tax incentives — Kantrowitz recommends investors focus on the lowest fees when the child is young. Direct sold plans eliminate the financial mediary of an advisor plan and come with less fees attached. However, there is some “peace of mind” offered from adopting an advisor plan, as there as is a financial professional on your side to help calm the storm during stock market turmoil.
  • Avoid investing in individual stocks
    “Investing in individual stocks, for many cases, is just far too risky. You might as well go out and buy a powerball ticket. What you want to do is invest in broad-based mutual funds like an S&P 500 fund,” Kantrowitz advises. Choosing these funds follows the broad trend of the market, meaning a greater probability of success versus opting for specific, individual stocks. Individual stock investing is the financial equivalent of putting all your eggs in one basket.
  • Consider investing in your home state
    “I think you should always consider your own state’s 529 plan. There maybe other benefits like matching contributions or seed money for saving in your own state. There are 34 states plus the District of Columbia that offer a state-income tax deduction or tax credit on your contributions to the state’s plan.” As an example, if the tax rate were five percent that’s like getting a five percent discount on tuition Kantrowitz explained.
  • Start and stay aggressive
    While Kantrowitz recommended age-based asset allocation plans, currently the most popular choice for the vast majority of households, he also had some suggestions for improvements. “I think they move off of the high percentage equities too quickly. I think that maybe you spend five to 10 years in 100 percent equities, and then you switch to age-based allocation.” This aggressive strategy is beneficial for potentially earning greater profits early-on to grow funds quickly.

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