How to Make the Most of Your 529 College Savings Plan

529 college savings plan

Start early enough, and socking away money in a 529 college savings plan is one of the smartest ways to offset the rising costs of tuition, which now averages $28,000 per year. Parents who open up a college 529 plan (named for its Internal Revenue Service code number) for their child’s future education can get tax-free earnings that saves money in the long run — and hopefully, borrow less in federal and private student loans.

Contributing to a 529 plan is quite straightforward; just open an account, name your beneficiary, and start depositing at will.

Tapping into it, however, isn’t quite as simple as withdrawing money from a checking account to reimburse your tuition bill. You’ll need to avoid certain income tax exceptions, state-specific rules, and other fees that weaken your earnings and ultimately, affect your ability to make the most out of a college 529 plan.

How well do you know your 529 college savings plan?

Don’t forget some of these specifics if you’re looking to maximize your 529 savings plan returns.

1. There’s more than one type of 529 plan.

A prepaid tuition plan allows savers to purchase units on a credit-based system towards tuition, fees, room, and board once it’s time to start living on campus.

Prepaid plans allow you to lock in tuition prices at eligible colleges and universities against inflation years ahead, so if a tight family budget and the amount of student loans you may borrow are priorities, this plan is likely a better fit than the standard 529 college savings plan. Always check which universities participate so your dollars will count.

There’s also the more well-known college savings plan where your money can be invested in a variety of ways and compound interest over time. Withdrawing your 529 college savings plan dividends is easy: Generally, you can have a check made payable to either the account holder or beneficiary/student, or towards the school. (However, consult with the college or university on their policy regarding receiving 529 funds, since some schools may differ.)

2. 529 plans vary from state to state.

Prepaid or standard, 529 plans are established and sponsored by states, where contribution limits are often in excess of $200,000. But they may differ depending on the state you live in. More than 30 states offer tax deductions and breaks on 529 plans, though several don’t, so confirm this before you begin investing. Residents of five states — Pennsylvania, Maine, Arizona, Kansas, and Missouri — are lucky enough to invest in any state’s 529 plan and get full tax benefits.

For prepaid plans, some states don’t guarantee that your investment will outpace the rate of inflation on tuition costs, so always check first to ensure your dollars will be enough to cover your out-of-pocket costs before pursuing student loans. Check out Saving for College, where you can search plans by state and learn more about building your saving plan.

3. Not all 529 college savings plan distributions are created equal.

The money you invest in a 529 plan will grow without being federally taxed. But not every 529 withdrawal is eligible for a tax break. For instance, tax-deducted 529 proceeds can’t be used to pay for education-related tax credits on your tax return, like the American Opportunity Credit or the Lifetime Learning Credit. Likewise, you won’t be able to claim deductions on tuition and school fees if you used tax-free 529 money to pay for them.

529 proceeds also don’t cover certain unqualified college expenses, like your student loans or transportation — even if it’s an airline ticket to and from campus between semesters. Off-campus commuter students may even have difficulty using 529 money to pay for room and board. To confirm exactly what your 529 proceeds may cover, contact the school and verify what is and isn’t covered per their rules. Tuition, books, and school supplies should be covered universally. Devise your own withdrawal plan to make sure your investment is maximized.

4. Watch out for penalty fees.

College 529 plans are a lot like IRAs: Withdraw your earnings too soon, and you may incur a penalty fee. Specifically, if you take out any dollars before the account beneficiary incurs any qualifying expenses (i.e. before your tuition bill is due), or for any non-qualifying expense (like a medical bill), a 10 percent penalty fee can be imposed on you.

There are some exceptions to withdrawing money early for non-qualifying expenses, like if an account’s beneficiary becomes disabled, passes away, or receives a scholarship or other type of educational assistance.

5. Other fees may apply, too.

According to the U.S. Securities and Exchange Commission, several fees and ancillary expenses may apply to your 529 savings plan. On a prepaid plan, you’ll likely face enrollment and administrative fees upon withdrawing funds. College savings plans charge the same, often with the inclusion of an asset management fee, which may all depend on the type of investment you have in place.

However, depending on the 529 plan in your state, you might be able to get some of these fees waived if you carry a large account balance or if you have an automatic deposit plan set up.

6. Don’t withdraw from the wrong 529 account.

If you’ve got more than one 529 plan (like investments in mutual funds, money markets, etc.), you’re making a mistake if you withdraw randomly from any account, even the one with the highest balance. Check your investments and see which ones have the best investment growth rates. Tap into those savings to receive the best tax breaks. Like any investment, gauging a plan’s growth potential ensures that you’ll be earning enough money to contribute aggressively towards college tuition.

7. Don’t pass on 529-based credit card rewards.

For 529 donors with excellent credit, consider opening up a credit card designed to complement your 529 plan. Many of them will give cash back or other rewards points that can be used towards your investment. Some cards include:

  • Fidelity’s Rewards American Express card
  • 529 Rewards Visa cards from Alabama CollegeCounts and Illinois Bright Directions
  • Barclaycard’s Upromise MasterCard

Some of these cards may not offer the same cash back or rewards percentages and also may not align with 529 plans in certain states, so make sure to read the fine print before applying.

8. Pay careful attention to withdrawal timing.

529 withdrawals won’t always qualify for a tax break if you don’t use them for qualifying educational expenses within the same tax year, so make sure your timing is right. Experts recommend keeping detailed records, not only for the IRS but your own financial activity, since a withdrawal made at the wrong time could compromise reimbursing your expenses.

Remember that there are a few ways to properly withdraw money from a 529 college savings plan:

  • Distributing the money directly to the account holder
  • Distribution to the beneficiary (most likely the student)
  • A school distribution

In this case, itemize and document every single tuition, school supply or relate expense in the school year so your 529 contributions are maximized to their fullest potential.

No two 529 plans are alike, just as the way you manage yours should be unique. Invest and maintain your account according to the schools you’re considering, what the tuition may be, and by locking into the best investments and interest rates available at the time you open. Don’t sit idle; monitor your investments and see how they grow over the years. If college is indeed years ahead for you, a child, or grandchild, it gives plenty of time to cultivate your 529 college savings plan and watch your money grow into something to keep college affordable and cost effective.

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