I originally wrote this article for NerdWallet and was compensated for the work.
The staggering costs of higher education are creating a financial barrier to entry for many families. These financial hurdles are at the forefront of parents with young children. Contending with these high costs are challenging for many families that believe paying for these higher education costs is a shared responsibility between the parents and their future college student. Devising a long-term strategy is essential in mitigating the impact of these future higher education costs and subsequent student loan debt. One of the most popular means for earmarking and investing money for future college expenses is in the form of a 529 college savings account. 529 college savings accounts have gained in popularity over recent years. In 2015 alone, net assets reached $253 billion compared to $157 billion just 5 years prior in 2010 for a 60% increase (Figure 1).
Figure 1 – Assets invested in 529 plans since inception
What are 529 college savings plans?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college expenses. 529 plans are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code which created these types of plans in 1996, hence the name 529 plan. There are two types of 529 plans: pre-paid tuition plans and college savings plans. All states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a pre-paid tuition plan.
Two-thirds of parents are not establishing 529 college savings accounts
Recently, financial website NerdWallet conducted a survey and found that 68% of respondents either don't have nor do they plan on establishing a 529 college savings account for their child or children. In contrast, 84% of respondents strongly believe in the value of a 4-year college education. This paradox may be rooted in the fact that this cohort is weary of the staggering costs of higher education with 78% stating that the financial return of a 4-year college education is in question. Awareness is certainly a factor to explain why parents may not be establishing 529 accounts for their children with 20% of respondents stating they were unaware of this type of savings vehicle. Alternatively, 12% of respondents stated that they have established alternative means of assisting with college expenses while 22% were unable to financially contribute to 529 accounts.
Who’s establishing and contributing to 529 accounts?
According to this NerdWallet survey, parents of the child opened the account 46% of the time while grandparents or a family member established the account 26% of the time. Families see funding college education as a shared responsibility and a recent study by the College Savings Plans Network (CSPN) corroborates these findings. Recently, the CSPN study showed that more parents and grandparents are opting to stash their money in 529 plans than ever before. By the end of 2015 there were 12.5 million active 529 accounts in the U.S., compared to 12.1 million accounts just one year earlier. And 55% of these accounts received contributions in 2015, up from 53% in 2014. Interestingly, out of those that established a 529 account, only 61% opened the account prior to age 3. Initiating the account as early as possible is essential when utilizing these 529 accounts as a savings vehicle for college. Considering these accounts have roughly an 18 year window to grow, opening the accounts as early as possible may make a meaningful impact to this college nest egg.
Advantages of 529 college savings accounts
529 plans offer federal and state income tax breaks:
Contributions are not deductible however earnings in a 529 plan grow federal tax-free and will not be taxed when the money is withdrawn and used for college related expenses.
In addition to the federal tax savings, 34 states, including the District of Columbia, currently offer residents a full or partial tax deduction or credit for 529 plan contributions.
If your state is a tax neutral state thus doesn't offer tax benefits to residents, you can choose any other state's plan.
Account holder will not receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals.
Only the earnings portion of a non-qualified withdrawal is subject to a 10% withdrawal penalty
Contributions will never incur penalty
Deposits limits to a 529 plan are up to $14,000 per individual per year ($28,000 for married couples filing jointly).
Non-qualified withdrawals will render your 529 plan a taxable account.
Account holder retains control of the 529 account:
The named beneficiary (i.e. child) has no legal rights to the funds so you can assure the money will be used for its intended purpose.
A 529 account owner can withdraw funds at any time for any reason -- but keep in mind that the earnings portion of non-qualified withdrawals will incur income tax and an additional 10% penalty tax.
Anyone can take advantage of a 529 plan:
Unlike Roth IRAs and Coverdell Education Savings Accounts, 529 plans have no income limits, age limits or annual contribution limits.
There are lifetime contribution limits that vary by plan, ranging from $235,000 - $400,000.
Exceptions to the 10% penalty tax rule:
If the beneficiary dies or becomes disabled
If the student decides to attend a U.S. Military Academy
If the student receives a scholarship
In all of these cases the earnings portion of the withdrawal will incur income tax.
Qualified withdrawals include:
Tuition and fees
Equipment required for course enrollment (including special needs equipment)
Some room and board expenses
Non-qualified withdrawals include:
Computers (unless the school requires them)
Student loan repayments
In the event your child does not attend college or receives a scholarship:
Change the beneficiary to another qualifying family member
Hold the funds in the account in case the beneficiary attends graduate school
Make yourself the beneficiary to further your education
The10% additional federal tax penalty is waived when scholarships are the reason for withdrawing funds
The scholarship has rendered your tax-free 529 investment into a tax-deferred 529 investment
Parents can still use their entire 529 balance on other non-scholarship expenses and not limit the tax benefit of the 529 plan
68% of respondents either don't have nor do they plan on establishing a 529 college savings account for their child or children.
84% of respondents strongly believe in the value of a 4-year college education.
78% stated that the financial return of a 4-year college education is in question.
20% of respondents stating they were unaware of this type of savings vehicle.
12% of respondents stated that they have established alternative means of assisting with college expenses.
22% were unable to financially contribute to 529 accounts.
Parents of the child opened the account 46% of the time.
Grandparents or a family member established the account 26% of the time.
Out of those parents that established a 529 account, only 61% opened the account prior to age 3.
A recent survey conducted by financial website NerdWallet found that 68% of respondents either don't have nor do they plan on establishing a 529 college savings account for their child or children, while 84% of respondents strongly believe in the value of a 4-year college education. This lack of correlation can be partially attributed to lack of awareness as 20% of respondents had not heard of this plan while 22% were unable to financially contribute. The 529 college savings plan may be one of the most effective means for saving money for college expenses. Establishing 529 plans are rising in popularity for both parents and grandparents as they were responsible for opening accounts 46% and 26% of the time, respectively. Contending with the staggering costs of higher education are challenging for many families however devising a long-term strategy (i.e. 529 plan) is essential in mitigating the impact of these future higher education costs and future student loan debt.