Why Use a 529 Plan? Because These Tax Advantaged Savings Plans Can Grant You Three Wishes
Saving for your child’s education through a 529 plan may help you pay less in taxes, take advantage of compound interest and put college within reach.
We all know the popular fable Aladdin and the Magic Lamp where a young man’s life is forever changed when he finds a magic lamp with a genie who grants him three wishes. In real life, sadly, there are no magic lamps. However, there is something else that can grant three wishes and change your child’s life forever. It’s called a 529 Plan.
A 529 Plan is a special kind of savings account set up to hold funds meant for your child (or grandchild, or other lucky kid that you care about) to pay for education. It gets this weird name because in 1996, Section 529 of the Internal Revenue Code authorized a qualified tuition program. It’s the same way the 401k got its name.
The magic of a 529 Plan is that it grants the following three wishes:
529 Plan Magic Wish #1: Pay less taxes
Before 529 plans were created, parents saving money for college would first pay taxes on any gains made prior to withdrawing the funds. For example, if a parent increased their child’s college savings by $100,000 and was in the 25 percent tax bracket, the government would take $25,000 – that could pay for a lot of text books.
Now all earnings from 529 plans are exempt from federal taxes when used for qualifying higher education expenses, according to the IRS website. Most states also offer a full or partial tax break for 529 plan earnings.
529 Plan Magic Wish #2: Compound interest
College tuition has been increasing at a rate of about 7 percent a year. No longer can you set aside money for college in a basic savings account because it won’t grow enough to keep up with college tuition inflation.
But you can choose to have funds in a 529 plan invested in mutual funds that can exceed a 7 percent annual return. Of course, compound interest magic works best when it has worked the longest. If you are able to set up a 529 when your child is still a baby, you will see the greatest magic.
529 Plan Magic Wish #3: Increase accessibility to college education
When you contribute consistently, a 529 plan can help make college a reality. Someone with a bachelor’s degree will earn 67% more than someone with a high school degree, so getting a college degree can be a path to a higher standard of living.
Frequently Asked Questions about 529 plans
Thanks to the Tax Jobs and Cuts Act of 2017, funds in a 529 plan can be used to pay for private K-12 education costs, according to information from the Financial Industry Regulatory Authority (FINRA). These education options may provide your child with the extra help needed to get into the college of choice and perhaps even qualify for more scholarships.
In most cases, your 529 plan will have a minimal effect on the amount of aid you receive and will end up helping you more than hurting you, according to savingforcollege.com.
Funds in a 529 plan weigh less on financial aid prospects than other factors, according to Investor’s Business Daily, and only 5.64% of a parent-owned 529 (with the student listed as beneficiary) is considered in federal aid calculations.
It’s important to remember that not all 529 plans are equal. Do your research to find out what 529 plan has the lowest fees, for example, or has the best investment track record. The financial services research firm Morningstar grades all 529 plans. In 2018 four plans were given a Gold level rating, including Utah’s my529 plan.
Taking the steps to set up a 529 plan are not as simple as rubbing a lamp, but they are not really that hard, and you will find the results really are magical.
Don Milne is Financial Literacy manager for Zions Bank.