What Is A 529 Savings Plan?

Financing May 2020 PREMIUM
Why Do Experts Advise Investing In One As Early As Possible

According to most financial experts, there are plenty of compelling reasons for a parent or grandparent to invest in a 529 Savings Plan that covers a child’s or grandchild’s college costs including tuition, room and board.

Gene McGovern, a certified financial planner, who runs McGovern Financial Advisors, based in Westfield, New Jersey, says there’s no limit to how much you can use to pay for college costs, which includes both tuition plus room and board, provided the money is used for “qualified education expenses.”

529 Savings are part of the federal tax code, and according to William Baldwin, a Forbes senior columnist, it helps a person’s money compound and grows tax-free while the child is growing up. Moreover, no state or federal income tax is charged when money is withdrawn for college.

Each state offers its own 529 Savings Plan, and some states, like California and New York, present the best deals, Baldwin says.  Some clients may relinquish some state tax benefits if they invest in a plan outside their home state, he notes.  Two-thirds of states offer tax breaks for citizens who invest in these plans.

Two major types of 529 plans are offered: education savings plan and prepaid tuition plan. But the saving plans predominate, and hold more than 90% of 529 plan assets, McGovern says.  Prepaid plans are dwindling in popularity, although Florida’s plan has managed to stay popular.

With the prepaid plans, savers acquire units at participating colleges or universities, which are mostly public and in-state. These fees generally can’t be allocated for room and board or be used for private elementary or secondary schools. Most of these plans are state-sponsored and have residency requirements.

McGovern notes that currently only 11 states now offer prepaid tuition plans, and nine of them are currently accepting new enrollees.

However, there is a third option, the Private College 529 plan, which is not state-sponsored but is owned by 300 or more participating private colleges, which include Stanford and MIT.

With the education savings plan, the client opens an investment account that pays for future higher education expenses, covering tuition, fees, and room and board, as well as computer hardware, educational software, and internet access. It can also be used for non-U.S. colleges and universities.  Some of these plans carry management fees.

Pew Charitable Trust reported that by 2017 about 13 million Americans invested in 529 College Savings Plan with an average savings of $23,000.  And yet only a third of Americans had heard of it and only a quarter were cognizant of its purpose.

Since the average debt of a collage graduate in 2017 hovered around $29,000, anything that can be done to reduce it and ease a graduate’s debt burden is beneficial.

Baldwin also urges investors to concentrate on saving for their retirement plan first and then pay attention to 529 Savings. Certified financial planner McGovern advises investing in a mixed stock and bond portfolio that grows more conservative as the child approaches college years, such as an age-based portfolio.  It may start out 100% stock but will be 70% by the age of 18.

Here’s what Francisco Valines, the director of Financial Aid, at the Florida International University, in Miami, and the certified financial planner Gene McGovern, said about 529 Savings Plans.  FIU has 58,000 students, of which 64% are Hispanic.

In addition to 529 Savings, Florida also offers Bright Futures, which enables students to attend a state university for free, and Florida Prepaid, an in-state program that parents can buy, similar to 529 savings.

Q: Experts advise that most parents invest in 529 Plans. Why?

Valines: Most of all, it’s a forced discipline. There are only a handful of ways you can use that money, including paying for your college education. In addition, they’re treated differently from other assets on the student’s financial aid application. If you have an investment account that isn’t for retirement, and you’re saving money to build up equity, you have to list it on the financial aid application.

McGovern: My understanding is that college can count up to 5.64% of the parents’ assets in their aid formulas each year.

Q: Any there any special reason Latino parents should take one out?

Valines: To ensure there will be funds to help the students go to college.

Q: How early should parents start investing?

Valines: The day the baby is born.  Because you have to pay less the more time you pay into the plan.  Then it’s an 18-year plan. If you pay $50 a month for 18 years, depending on the plan, it guarantees tuition and housing. If you wait until the kid is 10, you might be paying $250 a month.  And that’s harder to do.

McGovern: That’s true for the Florida pre-paid plan, not a college savings plan. The earlier the parents begin saving, the more time the money has to compound and grow tax-free.

Q: And how does a parent launch the investment? Does a parent go to a bank, financial advisor, and can it be done online?

Valines: The answer is all of the above, but it really depends on where you live. Many states sponsor a plan. Some states supply some funding or provide some economic advantages to participating in the plan.  I’d recommend starting in your home state’s educational office. In Florida, it’s called the Office of Student Financial Assistance; go to Florida Student Financial Aid. In Maryland, for example, it’s the Maryland Higher Education Commission.  But each state has a different name for it.

Q: Can a person go to a bank?

McGovern: Banks don’t have 529 plans.  The savings plan has to be sponsored by the state, but banks might participate in them.

Q:  What’s the minimum and maximum that can be invested in a year?

McGovern: The only contribution limit, per the IRS, is that they “can’t be more than the amount necessary to provide for the qualified education expenses of the beneficiary.” Each state has its own contribution limits, but they are very generous, ranging between $200,000 and $500,000 in total per beneficiary, depending on the state.

There’s also a special gift tax rule. Generally speaking, you can give up to $15,000 per year to anyone gift tax-free.  But for 529 plans, each parent can make up to five years of gift-tax free contributions up front, which takes maximum advantage of time to compound the investment. Two parents could contribute $30,000 for up to five years.

Q: But the money pays for college in your home state, correct?

Valines: With prepaid tuition plans, the money is earmarked for attending college in your home state.  But if your child wants to attend college in another state, most states allow you to apply it to another state.

McGovern: But savings plan can be used for college in any state, not just your home state. And you can invest your money in any state’s plan, not just your own state’s plan.

Q. If one child doesn’t go to college, can the money be transferred to another child?

McGovern: Yes, 529 money in a savings plan can be transferred to any family member, even cousins.

Q: What if your child decides not to go to college?

Valines: With prepaid tuition plans, most states allow you to cash out, but you’ll have to pay taxes.

McGovern: With savings plans, you’d definitely have to pay taxes plus the 10% penalty if you simply take the money out and don’t use it for education expenses. But it can always be rolled over into another family member’s 529 plan.  Furthermore, under the SECURE Act passed in December 2019, there are other options, including using the money for apprentice programs, repaying student loans up to $10,000 for the 529 plans beneficiary and up to $10,000 for plans held by any of the beneficiary’s siblings.

Q: How does taking out a 529 Savings Plan relieve a parent’s anxiety about college costs?

Valines: It allows you to know that tuition is covered, and in some cases, so is housing.  You don’t have to worry about doing that when a student attends school.  It’s by far the biggest expense for most students. Since most students commute, they’ll still have to cover those costs.

McGovern: Generally speaking, prepaid tuition plans can’t be used for room and board, but some prepaid plans apparently have a room and board option.  Savings plans can cover any education expense.

Q: If you participate in 529 Savings, how does it affect a graduate’s debt?

Valines: At FIU the average debt for most graduates is $19,000 (about $10,000 below the national average). Only 45% of FIU students borrow.

Q: Is there a point where it’s too late to invest in 529 Savings?

Valines: We usually say if they’re getting ready to go to high school, it’s probably too late. You only have four years. At that point, the plan will cost you a lot.

McGovern: The saving plans will only cost what you put into it, but by high school the money won’t have much time to grow.

Q: What if you have multiple children who are going to college. How do you invest in a 529 plan?

Valines: That’s why you start early because then it’s less expensive. It’s about setting priorities.

McGovern: But each 529 plan, whether prepaid tuition or savings plan, can only have one beneficiary.  So, if you have more than one child, you need to establish a separate 529 plan account for each of them.

Q: What role can grandparents play?

Valines: Huge. In many places, they can take the plans out for their grandchild.

McGovern: But 529 plans assets held by grandparents aren’t counted in the parent’s asset for financial aid purposes.  However, if the money comes out of the 529 plan held by grandparents to pay for tuition, it’s counted as income to the students and can affect financial aid in the next year.  This problem can be avoided if you wait until January of the student’s sophomore year to make any distribution from the grandparent held 529 plans.

Q: If you invest $1,000 a year, how does the compounding work?

McGovern:  If you invest $1,000 a year at the beginning of the year for 18 years, and it earns an average of 5% returns, you’d have $29,500 by the time the student starts college.

Q: But it’s not the be-all and end-all. Why not?

Valines: Because it doesn’t cover all college costs. We’re talking about tuition, fees and sometimes, room and board.  We’re missing books, commuting costs, and then miscellaneous cost like eating breakfast, lunch and dinner.

Q: Why use it for paying private school, elementary or secondary?

Valines: Because they’ve decided that it’s the primary education their child needs.

Q: If you’re not used to handling money, who can help?  High school advisors? College advisors?

Valines: In Florida, the Prepaid Plan has advisors.  Look to your state first and your local college. At FIU, we offer help for free for parents who live in Florida.

Q: What if you invest then desperately need the money, is there any way out?

Valines: Usually there’s some kind of out to get some money back, not quite the whole value. And you’ll have to pay taxes.

Q: Bottom-line, why does it make sense, if you have kids going to college in the future, to invest in 529 savings plan?

Valines: The key reason is that you know you’ll have a major portion of higher education covered.

Q: Anything we left out?

Valines: 529 Saving is only a part of your plan for paying your college education. You still have to fill out a FAFSA (Free Application for Federal Student Aid) plan and apply for access to federal grants, student loans, grants and institutional aid.

Contact Gary Stern at

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