Education Savings: Plan Or Perish?

Education savings plans are a way for parents to save for their children's education. There are different types of plans available, such as the Registered Education Savings Plan (RESP) and the 529 plan. These plans offer tax advantages and flexibility in how the funds can be used. For example, the 529 plan can be used for a wide range of education expenses, including college expenses, tuition for K-12 schools, apprenticeship costs, and student loan repayments. Similarly, the RESP can be used for tuition, books, tools, transportation, and rent. Education savings plans can help reduce the amount of loans needed for education expenses and provide a way to supplement other forms of financial aid.

What is a 529 plan?

A 529 plan is a flexible, tax-advantaged savings account designed to be used for a beneficiary's education expenses. It is a popular option for parents, grandparents, friends, and students who are planning for college, K-12 tuition, or apprenticeships.

There are two primary 529 plans: education savings plans and prepaid tuition plans. The former are tax-advantaged investment accounts designed for education savings, while the latter allows you to pre-pay all or part of the costs of an in-state public college education. The Private College 529 Plan is a separate prepaid plan for private colleges sponsored by more than 250 private colleges.

Earnings on contributions grow federal income tax-deferred, and withdrawals taken to pay for qualified higher education expenses are free from federal income taxes. These expenses include tuition, fees, books, computer expenses, or room and board.

There are no income restrictions on 529 plan accounts. To open the account, you must be a US resident, age 18 or over, with a US mailing and legal address, and a Social Security number or Tax ID. Anyone, of any age, with a Social Security or Tax ID number can be a beneficiary. The beneficiary can even be the same person who sets up the account.

There are several benefits to 529 plans, including:

• Federal tax treatment of gifts: Contributions up to $18,000 annually are not subject to the federal gift tax.
• Earnings grow tax-deferred: Investments are not subject to taxes while in the account.
• Tax-free withdrawals: Qualified withdrawals are not subject to federal income tax and are typically excluded from state income tax.
• State tax incentives: More than 30 states allow tax deductions for contributions to 529 plans.
• Roth IRA rollovers for unused funds: For unused 529 funds, account owners can roll over up to $35,000 into a Roth IRA in the beneficiary's name.

However, there are also some potential drawbacks to consider, such as:

• Must be qualified expenses: Any withdrawal from a 529 account that is not for qualified expenses is subject to income tax and a 10% penalty.
• Not all states offer deductions: While most states offer an income tax deduction for 529 contributions, some do not.
• No self-directed investments: You must invest 529 accounts in portfolio options offered by the 529 plan.
• Fees: All 529 plans have fees, although low-cost options are available.
• Ownership rules: An account owner controls a 529 plan account, not the beneficiary.

What is an Education Savings Account (ESA)?

An Education Savings Account (ESA) is a trust account created by the US government to help families fund educational expenses for beneficiaries. Beneficiaries must be under the age of 18 when the account is established, although this age restriction may be waived for special needs beneficiaries.

ESAs are designed to cover kindergarten through college expenses, and withdrawals are tax-free when used for eligible expenses. These expenses include tuition, books, equipment, special needs services, academic tutoring, and online education programs.

Total contributions to an ESA are limited to $2,000 per year per beneficiary, and the funds must be used by the time the beneficiary turns 30. The account must then be liquidated or transferred to a qualified family member to avoid penalties and taxes.

ESAs are similar to 529 plans, which are also tax-advantaged accounts designed for education savings. However, a key difference is that 529 plans can only be used for tuition, while ESAs can cover other school expenses. Additionally, there is no annual limit on the amount deposited into a 529 plan.

What are the fees and benefits of a 529 plan?

Fees and benefits are important factors to consider when deciding whether to open a 529 plan. Here is a detailed overview of the fees and benefits associated with 529 plans:

Fees:

The fees associated with 529 plans can vary depending on the state and the specific plan chosen. Here are some key points about the fees:

• Management and Administration Fees: These fees are charged for the management and administration of the 529 plan and typically range from 0.10% to 0.70% of the total assets.
• Underlying Investment Expenses: Most 529 plans offer a range of investment options, such as mutual funds and exchange-traded funds (ETFs), which incur their own expenses. Passively managed index funds typically have lower expense ratios, while actively managed funds aim to outperform the market and usually have higher expense ratios.
• Account Maintenance Fees: Some 529 plans charge a fixed annual or quarterly fee, typically between $10 and $25 per year. These fees may be waived under certain conditions, such as maintaining a high account balance or enrolling in automatic contributions.
• Sales and Distribution Charges: If you purchase a 529 plan through a broker or financial advisor, you may incur additional sales and distribution charges for their services.
• Transaction Fees: In addition to the annual maintenance fee, there may be transaction fees for specific actions, such as returned checks or rollover requests.

Benefits:

The benefits of 529 plans include:

• Tax Advantages: 529 plans offer tax-deferred growth, and withdrawals are tax-free when used for qualified education expenses. This includes tuition, fees, room and board, books, and related costs.
• Flexibility: 529 plans can be used for a wide range of educational expenses, including college tuition, K-12 tuition (up to $10,000 per year), apprenticeship programs, and student loan repayment (up to $10,000).
• High Contribution Limits: There are no annual contribution limits for 529 plans, and the total contribution limits range from $235,000 to $575,000 across states.
• State Tax Benefits: Many states offer tax benefits for contributions to 529 plans, such as tax deductions or credits. These benefits may be limited to residents who invest in their own state's plan.
• Easy to Open and Maintain: 529 plans can be opened with any dollar amount and do not usually require a minimum contribution. They are also simple to manage, with the option to set up automatic contributions.
• Prepaid Tuition Plans: Some 529 plans allow you to lock in current tuition rates for future attendance at selected colleges and universities, helping to save money in the long run.
• Transferability: 529 plans can be transferred to another qualifying family member if the original beneficiary does not need the funds. They can also be used for the account owner's own qualified educational needs or rolled over to a Roth IRA under certain conditions.
• Impact on Financial Aid: Assets in a parent-owned 529 account have a lower impact on financial aid eligibility compared to other savings methods.

Who can open a 529 plan account?

A 529 plan is a tax-advantaged savings account designed to help save for education costs. It can be used to pay for a beneficiary's qualified education expenses, such as tuition or textbooks. While it was originally limited to higher education, the funds can now be used for kindergarten through grade 12, as well as apprenticeship programs and student loan repayments, up to a limit.

There are two main types of 529 plans:

• 529 college savings plans: This is the most common type and generally considered the best and most flexible 529 option. Investments grow tax-free and can be withdrawn tax-free for educational expenses.
• 529 prepaid plans: This plan lets you prepay part or all of an in-state public tuition, locking in the tuition rate at the time of payment.

Anyone can establish and contribute to a 529 plan, meaning relatives and even friends can add to the pot and help fund the beneficiary's education. There are no age restrictions on who can open a 529 plan, and adults can open a plan for themselves.

To open a 529 plan, you'll typically need the child's date of birth and social security number, as well as information about your chosen investment choices. You can open a 529 plan directly through a specific state's plan or through a broker.

Some key points to note about 529 plans:

• They offer tax-deductible contributions, simplified investment options, and tax-advantaged investment growth.
• The money saved in a 529 plan is considered the owner's asset, which is preferred when it comes to financial aid formulas.
• You can change the beneficiary on your 529 account, allowing you to redirect funds to another family member if needed.
• There are no account minimums required to open a 529 plan, and contributions up to $18,000 annually are not subject to the federal gift tax.

What are qualified education expenses?

Qualified education expenses are any amounts paid to cover the enrollment of a student at an accredited post-secondary institution. These expenses can be paid by the student, their spouse, parents, or another party such as a friend or another relative.

Qualified education expenses include:

• Tuition
• Books
• Fees
• Supplies
• Equipment, such as laptops and computers

Expenses that do not qualify as "qualified" include insurance, medical expenses, student health fees, transportation, personal living expenses, or fees relating to sports activities.

Frequently asked questions