529 Savings Programs Explained

Minimize college borrowing with an active savings plan for your children. Saving a dollar today is better than borrowing one tomorrow. This simple example shows why:

  • Saving: Saving $100 per month with a 4% rate of return compounded annually over 18 years will provide $31,336 to pay for college.
  • Borrowing: At the start of college, let’s assume a student borrows $31,336 with an interest rate of 4% and a 10-year repayment schedule: the monthly payment starting six months after graduation would be $371, assuming the student does not pay interest while in college. The total amount repaid is $44,543.
  • Conclusion: Saving a smaller amount ($100) each month over a longer period of time (18 years) eliminates the need to borrow, pay $317 per month and total interest of over $13,200.

529 Savings Programs and Coverdell Education Savings Accounts have become very popular because each offers tax-advantaged opportunities to save for college. Earnings on the accounts accumulate tax-free and distributions made for college expenses are also tax-free. The primary differences 529 Accounts and Coverdell ESAs is that Coverdell has income restrictions (your Adjusted Gross Income needs to be less than $110,000 for single filers, $220,000 for joint filers), a maximum annual contribution of $2,000 per beneficiary and a requirement to use savings before the beneficiary reaches age 30.

Here are some benefits of 529 College Savings Account:

1. No income limitations: There are no income limitations associated with the 529 plan. Plans do have total aggregate caps on the amount that may be contributed, but these limitations are only for contributions, not for the total account value. 

2. Tax-free growth: 529’s offer the tremendous benefit of tax-free growth and the ability to withdraw the savings without paying tax as long as they are used for Qualified Education Expenses, which are broadly defined to include most expenses related to college.  In addition to federal tax advantages, many states offer state tax benefits as well.

3. It’s easy to switch beneficiaries.  Some parents are concerned that their child may not attend college or there may be money left over.  If that’s the case, the account owner may redesignate a beneficiary, including naming themselves. In the worst case, withdrawals for non-qualified expenses incur a 10% penalty and require taxes to be paid on the earnings.

4. Among the best savings options when considering financial aid: Families concerned that their savings may affect their eligibility for need-based financial aid should consider 529s. Ultimately, the way cash is saved is what’s most important. On the FAFSA (Free Application for Federal Student Aid) money saved in a 529 plan owned by the parent is weighed against financial aid eligibility at a maximum of 5.64%. For example, $10,000 saved in a 529 could end up reducing financial aid eligibility by $564. This is much better than having money in a standard savings account in the student’s name, where it can be weighed against financial aid eligibility up to 20%, which could be as much as $2,000 of reduced financial aid.

5. Great for estate planning: Grandparents find 529 Savings Plans to be a viable means of helping fund college for their grandkids while retaining control of their assets as part of their estate.  Money put into a 529 plan is removed from the taxable estate, but grandparents are able to retain rights of control over the 529 account even when funding is typically used to cover future college expenses for their grandchildren. With a 529 Plan, you are able to make a lump-sum contribution equal to five times the annual $15,000 gift tax exclusion to a beneficiary in a single year. This means that you can give up to $75,000 (if you are single) or $150,000 (as a married couple) at once, per beneficiary, without having to pay gift or estate taxes. And, if the 529 funds are used by the grandchild in the last two years of college, the funds don’t need to be reported on the FAFSA form.

Saving for college is an important way to minimize college debt and saving in a 529 plan or other tax-advantaged account works best for most families.