Blog Post

Saving for College: 529 Plans

Date Published: Mar 11, 2021

Smiling Female student holding books next to whiteboard

Saving for college can be a pretty big task depending on your academic goals and where you would like to further your education. For example, going to college out-of-state would cost more than going to college in-state, and private universities will cost more that public universities.

Luckily though, there are plenty of ways to help you save for college. One of those ways of saving, so you can get the degree and attend the school you desire, is called a 529 plan. This savings plan offers tax and financial aid benefits, and can also be used towards K-12 tuition.

Almost all of the 50 states have one 529 plan, with Wyoming being the only one that doesn’t. Michigan currently offers three plans: the Michigan Educated Savings Program (MESP), MI 529 Advisory Plan, and Michigan Education Trust (MET) Prepaid Tuition Plan. MET and MESP are both direct-sold and MI 529 is advisor-sold (Simon, SmartAsset).

So, What is a 529 Plan?

529 plans get their name from Section 529 of the Internal Revenue Code (IRC).  Section 529 was added to the IRC in 1996 to authorize tax-free status for qualified tuition programs. Fun fact though, the first 529 plan was a prepaid tuition plan started in 1986 by the previously mentioned MET.

In short, a 529 plan is a type of savings plan to help students pay for their education. It can be established by anyone, including non-relatives, for a child or adult beneficiary. The money that you may contribute to an account can be invested into an equity, fixed income mutual fund, money market funds, and/or exchange-traded funds (ETFs).

One cool, noteworthy aspect of 529 plans is that they are, in most cases, not subject to federal or state taxes, as long as the money is used for qualified college expenses.

Designed to pay for qualified higher education expenses, 529 plans don’t just cover tuition. They also cover other eligible expenses such as computer technology or equipment, room, board, books, and other eligible expenses.

Education institutions that 529 plans cover include colleges and universities, vocational schools, as well as private post-secondary institutions and K-12 schools. Better yet, kind of like a Roth IRA, funds made to a 529 plan are post-tax and are not deductible from federal income taxes (Saving for College).

529 Plan Options

There are two primary types of 529 plans and here are the key points of each. Keep in mind that both plans may charge applications fees as well as ongoing administrative fees:

Savings Plans

  • Similar to Roth IRAs in the fact that they are a tax-advantaged method of investing money long-term.

  • Amounts for savings plans are contributed up to the dollar limit of the savings plan.

  • Savings plans can only be offered by states.

  • You have the opportunity to invest the money in a variety of mutual funds or several other investment options.

  • A 529 Savings Plan may increase or decrease in value based on how the investment option performs.

  • Subject to market risk or the possibility of the plan losing value.

Prepaid Tuition Plans

  • Can be offered by both states and higher education institutions.

  • Allows you to prepay for all or certain semesters at a college or university at its current prices, protecting you from inflation.

  • Guaranteed by states.

  • They have age restriction, residency requirements, and stricter criteria on what expenses they can cover.

  • If the plan is not used towards expenses at a predetermined school, the value of the plan's payments may not be enough to cover the cost of a similar institution on a predetermined list. This could leave you, the beneficiary, to cover the difference out of pocket.

When it comes to picking the right plan for you, focus on which one has the features and benefits that appeal to you the most. If you want to be able to freely choose which educational institution you want to go to, then you may want to go with a savings plan. If you like being safe from rising tuition costs, aka inflation, then prepaid tuition is what you would want to enroll in.

However, when deciding on a plan be sure to weigh the pros and cons of the features and benefits of the plans offered by your state with the plans offered by other states. Pay attention and compare features such as investment choices, fees and other added expenses, plan restrictions/limitations, and if the plan allows for rollovers from other education savings programs.

Whichever plan you choose to go with, the big thing to do is make a choice and do so as early as you can.  Starting early increases the compounding effect of the earnings on contributions. For prepaid tuition programs, the cost of tuition is typically less if the prepayments are made earlier than later.

How to Withdraw Money

Like we said before, withdrawals from a 529 plan are tax free, if the cash is put towards qualified higher education expenses at an eligible institution. You have three options to choose from when the time comes to begin withdrawing the cash you have saved.

  1. Sending a check to the school: This seems simple, right? Well sadly there are some problems that could arise by sending the check right to the school. One thing that could happen is that the school could adjust the financial aid award based on the amount that is sent from the 529 plan. This could cause you to dish out additional funds in the plan or cover the gap from out of your pocket or bank account.

  2. Sending the check to yourself: This method can avoid the issue that comes with sending a check to the school, but it does make you responsible for ensuring that the expenses are paid. You will also have to report the distribution on your tax return, in turn requiring you to file a Form 1099-Q, which is always fun. This could potentially cause taxes and penalties on the distribution, even if the funds have been put towards qualified education expenses.

  3. Sending the check to your beneficiary: This is probably the best option to take or at least the one with the least amount hassle. This method will get you past any potential issue of decreasing financial aid or throwing obstacles your way during tax filing. As long as the funds are used to pay for education expenses, the distribution is tax free and won’t cause any problems at tax time. Just make sure you, the beneficiary/student, file your own return. In the event that a distribution is made taxable, the funds would be taxed at the student's tax rate and not the plan holder’s tax rate. You should also check or work with your tax preparer when filing their return (Kagan, Investopedia). 

Whichever option you are leaning towards, be sure to check with your plan administrator to make sure it’s the best option for you. A 529 Plan is a great way to save money for furthering one’s education and offers parents and students a plethora of awesome benefits