What is a 529 plan? | Adirondack Bank

Did you know that having a plan to save for your child’s college education increases the chances that they will attend?

Whether you are just starting to save for college for yourself or you’re thinking about saving for someone else, 529 plans are an option that is worth considering. Although more than 75% of undergraduate students use financial aid such as scholarships, grants, or loans to pay for college, more than half of students surveyed have never even heard of 529 plans.

What’s a 529 plan?

529 plans may be used to save and pay for education. Some form of a 529 plan is offered in every state in the U.S., and the District of Columbia.

There are two types of 529 plans—Prepaid Tuition Plans and Education Savings Plans.

Prepaid tuition

Allow you to purchase credit at colleges and universities
May only be used to pay for higher education
May only be used to pay tuition (not other fees associated with attending school, such as room and board)

Education savings

Allow for more freedom to choose a school, including any public or private college or university, sometimes even ones outside of the U.S.
Allow withdrawals of up to $10,000 tax-free per year per student for tuition at any public, private, or religious elementary or secondary school
May be used to pay tuition, fees, books and supplies, equipment required by school, room and board, and even digital devices such as computers and tablets if used for higher education

If you choose an Education Savings Plan (ESP), you may decide to open it in any state that offers it as an option — even if you don’t live there. In fact, you don’t even have to open your plan in the state where the school you want to attend is located. It’s important to research which state’s plan options would benefit your situation the most.

Benefits of 529 plans (Prepaid and Education Savings Plans)

Let’s look at some of the benefits associated with 529 plans. Since these plans vary by state, it is extremely important that you take the time to do your research.

The funds in your plan are invested, and you don’t have to pay taxes on investment earnings unless you use funds for unqualified expenses.
Withdrawals are tax-free when used for qualified education expenses.
Anyone may contribute to 529 plans — not just the account owner.
The beneficiary is transferable. For example, if the student ends up getting a full scholarship to college, the funds may be reallocated to another family member.
Some states offer a state income tax deduction for contributions to 529 plans.

Benefits of Prepaid Plans

Allow you to lock in the current cost of education when you open the account — even if tuition increases during the years the account is open.
Some states provide insurance on your plan so that funds are guaranteed when the student needs them.

Benefits of Education Savings Plans

Not limited to in-state public college or state residents.
May open an account in a state other than your state of residence — it doesn’t even have to be the state in which the school you hope to attend is located.
May be used to pay for college expenses other than tuition.

Potential risks of 529 plans

As with any financial commitment, it is important to understand the potential drawbacks associated with 529 plans before you commit to one.

Since the details of plans will depend on which state you decide to get a plan from, let’s focus on risks associated with the two types of 529 plans.

Risks of prepaid tuition plans

Some states do not back the tuition plan, meaning if there is a severe state budget shortfall, it could put your money at risk.
Plan may have to be opened in your state of residence and used at in-state colleges or universities.
Funds may only be used for tuition, not for other education-related expenses.
Some plans have age or grade limits for beneficiaries and/or limit enrollment to a certain period each year.

Risks of education savings plans

Tuition prices are not locked in.
State may not guarantee or back plans.
Since funds are invested, you risk losing money or your investment not growing enough to pay for college.

How to open a 529 plan

Once you decide that a 529 plan is the right choice for you or your family, it’s time to take the steps needed to open your plan.

Research both types of 529 plans. You are already off to a great start! Review the details of both types of 529 plans to decide which makes the most sense for your individual situation.
Review in-state and out-of-state plan options. Take a look at options offered both by the state in which you live and other states. Plan details, such as maximum contribution limits, vary by state, so you may choose to open a plan in a state where you don’t reside or one where you don’t plan to attend school. Remember — going with an in-state option may give you a state tax benefit.
Apply for a plan by visiting the state-sponsored website or other resource. Most states have websites that will guide you through the enrollment process for their plans. At the time of opening the account, you should expect to provide information about yourself and the plan beneficiary (if it is not you). For ESPs, you’ll typically select how your funds will be invested and provide an initial deposit to open your plan.
Monitor your plan. Once you start depositing funds in your plan, be sure to regularly monitor your account to keep track of how your investments are performing. For ESPs, this will allow you the potential opportunity to make changes in your investment selections and to know what additional savings you need to meet your education savings goals.

How much should I contribute to a 529 plan?

The amount you ultimately decide to contribute should depend on your personal budget and education goals.

For example, you may decide to contribute a greater amount if you are planning to use funds for both K–12 and higher education. As you budget for contributions, here are a few limitations to keep in mind.

All 529 plans: All 529 plans allow donors to front load five years’ worth of contributions gift-tax-free, meaning individuals may give up to $75,000 or married couples may give up to $150,000 without incurring the gift tax.
Prepaid tuition plan: Prepaid Tuition Plan rules vary by state, but many people choose to contribute up to $15,000 per year per beneficiary.
Education savings plan: Education Savings Plan rules vary by state, but most states allow you to contribute up to $250,000 per beneficiary in total, though some states allow more.

How much does a child need in college savings?

If you plan on sending your child to a four-year college, a good rule of thumb is to multiply the current age of your child by $2,500. This will estimate how much you will need to save for just ONE year of college. This is assuming your child attends a public university and does not account for inflation or interest earned.

Key points

There are lots of important considerations to think about when deciding if a 529 plan is the right choice for you to reach your education savings goals. Here are a few key points to keep in mind.

Compare options: There are two main types of 529 plans — Prepaid Tuition Plans and Education Savings Plans.
Vary by state: 529 plan offerings vary by state, and you do not have to use a plan from the state where you live.
Tax advantages: Investment earnings and withdrawals for qualified expenses are tax-free.

Next steps

Review your options: Review the information you’ve learned about the differences between types of 529 plans and do additional research if needed.
Weigh the benefits and risks: Check out the tax advantages you would receive by using an in-state plan, and then compare those with the benefits and risks of going with a plan from a state in which you do not reside.
Visit the specific plan’s website: If you decide to open a plan, visit the appropriate state’s website, and get started on your application.

The information in this article was obtained from various sources not associated with Adirondack Bank. While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. Adirondack Bank is not responsible for, and does not endorse or approve, either implicitly or explicitly, the information provided or the content of any third-party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. Adirondack Bank makes no guarantees of results from use of this information.

Article written by EVERFI

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