Got a Teen? It’s Not Too Late for a 529 Savings Plan

The Squeeze

• Starting a 529 college savings plan — even if your kid is in high school — can still be a great way to put away and grow funds.
• Depending on the type of 529 plan, you can prepay credits at local state schools or save for college costs anywhere in the country.

Once you have a baby, the 529 college savings plan emails hit hard. But you aren’t always in the position to start saving just as you are navigating new-parent life. When your children are young, college can seem eons away — but as the adage says, time flies.

Before you know it, it’s the first day of high school, and it dawns on you that your child will be a college freshman in a few short years. If you’ve been unable to start a 529 plan until now, don’t worry. You can still reap the benefits these plans offer — even if you open one with just a few years to spare. 

It’s ideal for your child to start college with something saved, even if you can only put away a modest amount per month. According to the Federal Reserve, outstanding U.S. student loan debt reached $1.7 trillion at the end of 2020. A 529 college savings plan allows you to make whatever dent in college costs you can afford for your child while taking advantage of federal (and occasionally state) tax benefits. 

What is a 529 college savings plan?

Financial institutions, states, state agencies, or educational institutions sponsor “qualified tuition plans,” which are basically savings plans with tax advantages used to save for education costs. They are known as 529 plans because they are outlined in Section 529 of the Internal Revenue Code. Though designed specifically for college, they are sometimes also used for private elementary and secondary school costs (up to $10,000). Grandparents also can help fund a 529 plan or even start one to help prepare their grandkids for the future.  

What are the tax benefits of a 529 plan?

Any investment earnings grow tax-free over time — even if it’s a relatively short period. The tax benefits offered by investing in a 529 vary, depending on the state you’re in and the plan you choose. You might be able to deduct your contributions from state income tax or receive grants.  

If you withdraw for higher education expenses that meet the plan’s established qualifications, the funds won’t be subject to federal, and in many cases, state income tax. If the money is withdrawn for any other reason, it’s subject to federal income tax and additional federal penalties of 10% on earnings.

Some states offer tax credits for 529 plan contributions, while others provide tax loopholes for front-loading 529 plans. It’s well worth asking a financial expert in your state for guidance.

How do 529 plans work?

College 529 plans work in a similar way to Roth IRAs in that you make contributions of after-tax dollars into a college savings investment fund. This fund can consist of mutual funds, exchange-traded funds (ETFs), bonds, or other types of investments banks offer. These investments should gradually skew more conservative the closer to college-age your kid gets. 

You aren’t limited to the 529 plans in your state — you can participate in almost any 529 plan you want across the country. However, it may be worth exploring the options offered by your home state first. You might be eligible for a tax deduction or tax credit for contributing, a grant, or fee discounts or waivers. 

What are the different types of 529 plans?

There are generally two types of 529 plans: education savings plans and prepaid tuition plans. Every state offers its residents the option of enrolling in at least one type of plan.

Education savings plans allow you to put away money for your designated beneficiary’s qualified higher education expenses, including tuition, fees, and room and board. You can usually use this kind of plan at any college or university — some even outside of the U.S. Check the fine print before enrolling; some of these plans have residency requirements for the parent or the beneficiary. 

Prepaid tuition plans allow the investor to buy credits at (usually public, in-state) colleges and universities for future tuition and mandatory fees. Often sponsored by state governments, these 529 college savings plans require you to be a resident of the state that offers the plan, and the funds have restrictions — for example, room and board are exempt. Some states guarantee this money, meaning the stability of the investment is subject to the sponsor. Some states don’t. Again, check the fine print before signing up. If your kid opts to go to a school out-of-state, you might lose money with penalties. This plan is a good option for an older child that has a good idea of what college they plan to attend. 

What are the 529 plan fees? 

Like with everything else, expenses and fees may be embedded into the fine print of your 529 plan, so it’s important to take a close look at the details before choosing one. Prepaid tuition plans sometimes charge enrollment fees and administrative fees. Education savings plans may charge you to apply or enroll, annual account maintenance fees, and ongoing program management fees. Ongoing asset management fees are standard when buying this kind of plan from a broker. Some costs can be waived, depending on your arrangement with the brokerage. Several states offer education savings plans without broker fees.

Will investing in a 529 plan affect our financial aid outcome?

Every school looks at 529 plan savings differently when looking at your Free Application for Federal Student Aid (FAFSA). Investing in a 529 plan can have an impact on your child’s ability to receive need-based financial aid awards. 

How should I plan my 529 plan investment portfolio?

Some education savings plans have pre-set options that are part and parcel of the deal, and you may not get to choose. If your program offers the opportunity to select your investments, you might want to consider a more conservative approach when saving for a high schooler than you would a baby. For example, for a 13-year-old, stocks and mutual funds should only comprise about 25% of your portfolio while, to avoid loss, more conservative investments, like bonds, CDs, or money market funds, would make up the rest. For a 16-year-old, it helps to take an even more conservative approach — half of your investments could be in short-term reserves while the other half could be in bonds. Make sure you read the fine print of each plan to understand how your investments will work for you.

How to learn more about starting a 529 plan

Start by seeing what plan is offered by your state — many offer deductions and benefits. From there, ask around to see what brokerages offer as opposed to what is provided by your state for the best deals with the lowest fees. When it comes to socking away cash for college, 529 college plans prove saving is better late than never.