College savings plans: A simplified guide for parents

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College is more expensive than ever, so if you have kids or are thinking about having kids, it’s a good idea to start saving money as soon as possible. There are lots of different ways to save your money, but a 529 college savings plan is the most financially efficient way to invest in your child’s future. 

Bob Petix, Senior Wealth Strategist with Wells Fargo Wealth and Investment Management, broke down everything parents need to know about 529 plans, and how to invest wisely in your child’s education.

What is a 529 plan?

A 529 plan is a college savings account that offers a tax-free way to invest money for qualified education expenses. Parents or grandparents can open a 529 plan for a child, and start investing money right away. 

As Petix explains, “If you establish a 529 plan for the benefit of a beneficiary, the contributions will be able to grow tax-free during the growth stage of the account, and then distributions are later made and used for qualified education expenses.”

Your contributions will grow over time, and can be withdrawn to use towards all kinds of education-related expenses, including tuition for college, graduate school, private K-12 schools, and even alternative learning environments like trade schools.

Why should parents or grandparents start a 529 plan?

The biggest upside to the 529 plan versus other types of savings or investment accounts is the tax-free growth of your contributions. Bob Petix emphasized that families should take advantage of this benefit: “It’s very rare that the tax code is so generous, but I think there’s a recognition that especially higher education costs have gotten very burdensome for a lot of families.”

Furthermore, under a new rule established this year, 529 plans established by a grandparent do not count towards a child’s financial aid income qualification. That means that kids can qualify for more financial aid for college because the 529 plan funds are not taken into account, even if the child’s parents have been contributing funds.

6 tips for using a college savings plan

Petix shared some tips to help families take advantage of 529 plans, and some pitfalls to avoid when saving for your child’s future:

  • Be realistic about the future. Is it likely that your child will attend an expensive private university? Or more likely that they’ll attend a state school? Some kids don’t end up continuing their education after high school. As impossible as it is to predict your child’s path, it can help to take a realistic look at their options and plan for the most likely scenario to avoid over- or under-investing in the plan.
  • Start early. You can set up a 529 plan as soon as your child is born and start making contributions right away. The longer money is in the account, the more it will grow over time.
  • Start strong, then reevaluate. Especially in the early years you can be more aggressive about your investment to take advantage of the compound interest. As your withdrawal date gets closer, you may want to invest less as you evaluate your anticipated education expenses.
  • Consolidate plans for multiple kids. You can have separate plans for each kid, but you can also direct funds to related beneficiaries to include more kids in the benefit if there are funds leftover.
  • Think about your exit strategy. If there are no other kids to divert leftover funds to, you can roll over up to $35,000 into a Roth IRA retirement account without penalty. But keep in mind that there is generally a 10 percent penalty, plus taxes, if you withdraw the money for other non-education expenses. 
  • Consult with an advisor. Work with a financial advisor as you get ready to set up a 529 plan. They can help calculate your potential investment and anticipated education expenses.

Mckenna Saady is a staff writer and digital content lead for ParentsTogether. Before working for nonprofits such as the Human Rights Campaign and United Way, Mckenna spent nearly a decade as a child care provider and Pre-K teacher. Originally from Richmond, VA, she now lives in Philadelphia and writes poetry, fiction, and children’s literature in her spare time.