Are you overwhelmed thinking about saving for college? One smart way to finance your child’s education after high school is by starting a 529 college savings account. What’s a 529? A 529 account allows gains to grow tax-free if the funds are withdrawn for qualified educational expenses.
“Many parents don’t take advantage of this useful vehicle, often because they don’t understand how flexible these programs can be,” says Tim Gorrell, who manages the overall operations of Ohio’s 529 Plan, CollegeAdvantage.
Let’s look at six common misconceptions about 529s… Are any of these holding you back from saving for your child’s future education?
If my student earns a scholarship, we won’t need 529 college savings funds.
Do you have an aspiring athlete, musician or math whiz on your hands? Often special talents can indeed earn them a scholarship to school, but very rarely will it cover all the costs of attendance. Ancillary items like books, computers, and other education-related expense are probably not covered. That’s where 529 funds can be useful, to fill that gap.
If the majority of expenses are covered, congratulations! In that case, you may choose to use a 529 savings account to fund a master’s degree down the road. Or, you can put it to another use — skip down to Misconception 5 for more ideas.
We don’t need a 529 because my student hasn’t shown interest in attending college.
If you doubt your child plans to pursue a four-year education, a 529 plan’s flexibility still makes it a great choice and smart investment for them, too. Withdrawals can be used to pay for so much more than traditional college; you might be surprised at the variety of 529 uses. You can use a 529 to pay for education at community colleges, trade schools, and training at places such as cosmetology or culinary school, too. A 529 can also pay for upfront materials required for apprenticeships.
Gorrell says, “We like to remind people it’s quite likely their child will do something after high school —which, generally, will come with a cost — and that funds from the 529 can be used at any federally accredited educational institution.”
Other savings vehicles serve the same purpose as a 529 college savings account.
Another popular way parents save money for their child’s education is to fund custodial accounts under the Uniform Gifts to Minors Act/Uniform Transfers to Minors Act (UGMA/UTMA). Gorrell is quick to point out that although his organization doesn’t offer financial advice, he recognizes that every family has different financial goals and he believes it’s important that parents understand a key difference between 529 plans and UGMA/UTMA accounts.
Gorrell says that many parents initially believe UGMA/UTMA accounts might be more flexible, since funds can be used for purposes other than education while still offering tax benefits. Yet they often don’t realize that these accounts automatically transfer to the child when they turn 18, which means they can use the money for whatever they choose, education or otherwise. “These might be funds that were saved for the intent of post-high school education, but then the beneficiary decides they want to tour national parks, and the family has no recourse,” Gorrell notes.
Furthermore, if the family opts to use the money in an UGMA/UTMA account to pay for college, institutions will consider the account as the child’s asset since the account is in their name, which then could negatively affect their ability to qualify for financial aid.
My student can’t use our state’s 529 plan to pay for an out-of-state education.
All states (except Wyoming) and the District of Columbia offer at least one 529 plan. What you might not know is that residents can choose a plan in any state, even if they don’t reside there, and these plans don’t restrict the ability to choose schools in out-of-state locations. Investing in your own state’s plan may come with tax benefits, however, so look at plans from your home state first and take that into account while you’re evaluating account fees and performance before deciding where to invest your money.
“Here in Ohio, we want people to invest with us, then also choose an exciting educational opportunity and a great career option to ultimately work and thrive here in Ohio. But, we also realize not everyone does that, and Ohio’s 529 CollegeAdvantage plan won’t restrict them from pursuing other options,” Gorrell says.
If the designated beneficiary doesn’t use the money in their 529 college savings account, the funds will go away.
If your young adult wants to take a gap year after high school, or other time off to consider their options, set your mind at ease about money set aside in a 529 savings account for their education. A 529 plan has no expiration date attached to it. “Should your child desire to go back to school at any time, there’s no shelf life on the money,” Gorrell says.
Another great example of the plan’s flexibility is that you can transfer it to other relatives, for example, to other children, grandchildren, cousins, in-laws. Alternatively, you can keep it for yourself to pursue your own education. Given all that flexibility, most people find a way to use the money on educational expenses.
Worst case scenario? You withdraw the money from your 529 and pay tax on the earnings, plus a 10% penalty. In other words, you won’t lose it completely.
If I didn’t open a 529 when my baby was born, it’s too late now to invest in one.
Many people aim to start saving early, but sometimes life gets in the way. Don’t let that dissuade you. Even if you don’t know when to start a 529, Gorrell says, “It’s almost never “too late” to open a 529 account. Even if you start investing while your child is in high school, you can still take advantage of tax incentives in Ohio’s plan if you’re a state resident. Ohio’s plan also allows you to withdraw money from the fund to repay up to $10,000 in student loans per beneficiary.”
In summary, a 529 plan is a great way to save for your child’s education. It’s a tax-free savings account that offers flexible spending, and it’s transferable among relatives. The most important thing to remember is that you should never sacrifice your own retirement savings to fund college. As Gorrell reminds us, “If needed, you can borrow to cover college costs. You can’t borrow for your own retirement.”