By Kyle Louvar, CFP®, AIF®
While 529 plans are one of the most popular ways to save for college expenses, there are many factors that should be considered before you start contributing.
Here are four things to keep in mind if you’re thinking about starting a 529 plan for your child or children:
What Is a 529 College Savings Plan?
A 529 plan is a state-sponsored education savings account that allows earnings to grow tax-free. There are two categories of 529 plans: prepaid tuition plans and college savings plans.
Prepaid plans let you pay future tuition costs at eligible private and public colleges and universities at today’s prices; some age or grade limits may apply. College savings plans have no age or income restrictions and allow you to save anywhere from $235,000 to $550,000 per child, (1) and later use these assets tax-free for qualified education expenses.
Your Child May Get Scholarships
The most common question asked regarding 529 plans is: “What happens if my child gets a scholarship?” It’s a valid question since scholarships are a significant component of most financial aid packages. In fact, in 2020, nearly 58% of families used scholarships to pay for at least a portion of their child’s college education. (2)
If your child gets a scholarship and doesn’t need the money in their 529 plan, it can be withdrawn penalty-free. But you will have to pay regular income tax on all of the earnings. Even though the government does not charge a penalty, having the money needlessly tied up for years presents an opportunity cost in and of itself.
College Attendance Is Not Guaranteed
No matter how much you want your child and/or children to attend college, it’s not guaranteed. Your child may end up being the next YouTube sensation, major recording artist, or join the military. Or something could happen that makes them unable to pursue higher education. What happens then?
In those cases, you can remove the funds from the account, but you will have to pay taxes and a 10% penalty on all the growth.
Penalty for Nonqualified Expenses
You do not have to pay taxes on earnings in a 529 as long as the funds are used for qualifying higher-education costs. (3) If you spend the money on nonqualified expenses, however, you will have to pay income tax and a 10% penalty on earnings. Unfortunately, even items that are related to higher education and may seem like they should be qualified are actually not qualified.
Nonqualified expenses include:
- Application and testing fees
- Transportation costs
- Health insurance
- Extracurriculars and sports
Note: Room and board are only covered at eligible institutions if your child is enrolled at least half time.
One of the benefits of a 529 plan is that you can transfer the funds to another family member or relative if your child does not end up using the assets. Not only that, you can also use a 529 plan to pay for your own education if your child no longer needs the funds. This is a penalty-free option that many parents don’t realize is available.
Additionally, 529 account holders can use up to $10,000 annually on pre-college educational expenses, such as K-12 private or religious school tuition. And thanks to the SECURE Act of 2019, you can also use your 529 savings to pay for apprenticeship fees, homeschooling, or up to $10,000 of qualified student loan repayments (including those for the 529 plan recipient’s siblings). (4)
Making the Right Choice
If you’re considering a 529 plan for your child’s college savings, we would love to walk you through the process and help you make the right decision for your family’s long-term financial needs.
At Guided Capital Wealth Management, we utilize our proprietary process, The Paradigm FORMula, to help you create a dynamic plan that can help you reach your financial potential and keep you on track toward achieving your goals. Schedule a FIT meeting by contacting us at (832) 975-0711 or by email at firstname.lastname@example.org to learn if we are the right people to guide you on your financial journey.
Kyle Louvar is the CEO and Wealth Management Advisor for Guided Capital Wealth Management, a fiduciary financial advisory firm offering fee-based advice, guidance, and education. After seeing the impact that the 2008 financial crisis had on families, Kyle became fully committed to helping his clients develop a financial plan that changes as their lives unfold and their needs evolve. Spending nine years working for one of the largest brokerage firms on Wall Street, Kyle holds a high value for process, expertise, objective advice, and customized solutions. His goal is to help his clients experience confidence in their financial future through a disciplined process of financial planning, investment management, and sound financial decision-making.
Kyle graduated from New Mexico State University, where he was a proud 4-year letterman in football for the Aggies and where he’s sat as an NMSU Foundation board member since 2015. Kyle holds the CERTIFIED FINANCIAL PLANNER™ and Accredited Investment Fiduciary® certifications. When not helping his clients, Kyle enjoys spending time with his wife, Nicole, and their two daughters. You can often find him coaching his daughters’ softball teams, playing golf, cooking, and traveling. To learn more about Kyle, connect with him on LinkedIn.