Although I had to pay for my own college education, I avoided student loans for the most part by choosing an inexpensive school, working full time, and qualifying for scholarships. But those options might not be enough for my kids to avoid taking out loans when they start college.
After all, the average household student loan debt has increased by 828 percent over the last 18 years, according to Federal Reserve data analyzed by Axios. Who knows where it will be in another 18 years?
That’s why having a 529 plan or another college savings plan is essential for parents who want to help their kids avoid as much student debt as possible. Read on to learn whether a 529 plan is right for you.
What is a 529 plan?
There are two types of 529 plans: the 529 college savings plan and the 529 prepaid tuition plan. Although it’s important to compare the features of both plans, we’ll focus on the more popular 529 college savings plan here.
Most states have a state-sponsored 529 college savings plan that allows you to invest your contributions. The account has one beneficiary, and you can withdraw the earnings tax-free for the beneficiary’s education-related expenses.
Pros of having a 529 college savings plan
The money you earn in a 529 college savings plan account is free from federal taxes if you use it for qualified education expenses. According to the IRS, eligible expenses include:
- Tuition and fees
- Books, supplies, and equipment
- Room and board
If you use the money for nonqualified expenses, not only will the earnings be taxable, but you’ll also pay a 10 percent penalty. One exception is if your child receives a scholarship, at which point you can withdraw up to the amount of the scholarship penalty-free.
In addition to the federal tax advantages, you also might get incentives from your state. For example, the state of Utah gives me a 5 percent state tax credit on contributions I make to my son’s 529 plan — up to $192 per year.
Not all states offer state tax incentives, though. Check to see if your state does before you apply.
You can shop around
If you don’t like your state’s 529 college savings plan, you’re free to choose one administered by another state. Some states offer lower fees, so you can compare your options to find the best 529 plan for you.
The only caveat is that you can’t get a state tax deduction on another state’s plan if you’re not a resident.
Account limits for 529 college savings plans are set on a state-by-state basis. They’re generally based on the amount necessary to cover qualified education expenses.
For example, the state of Utah estimates the education costs for four years of college and two years of graduate school to be $430,000. This amount is the maximum account balance for one beneficiary, and you can contribute as much as you want up to that amount at any time.
Keep in mind, though, that federal gift tax consequences might apply if you contribute more than $14,000 per year (or $28,000 for married couples).
Cons of having a 529 college savings plan
Limited investment options
Some states offer limited investment fund selection for their 529 plans. If you’re an inexperienced investor, you might not think much about it. But if you’re a savvy investor, you might want more control over where your money gets invested.
If you shop around, you can seek out a state plan that offers more fund options. But there’s no guarantee you’ll get low fees along with it.
Some plans have contribution requirements
If you want to save for college at your own pace, your options might be limited. Most states have a monthly contribution requirement, and some even have a minimum initial deposit.
For example, South Dakota’s 529 college savings plan requires that South Dakota residents open an account with at least a $250 opening deposit ($1,000 for nonresidents). Going forward, you must contribute at least $50 per month.
There’s no guarantee your child will go to college
Let’s say your child decides to skip college. What happens to all that money in your 529 college savings plan?
If you have another child, you can make him or her the beneficiary instead. But if you don’t have other kids or you have sufficient savings for them, any nonqualified withdrawals you make from your 529 plan will be subject to taxes and a 10 percent penalty.
Helpful alternatives to a 529 plan
If you’re not sold on the idea of using a 529 college savings plan, here are a few other options you can consider.
Coverdell Education Savings Account (ESA)
For the most part, a Coverdell ESA functions similarly to a 529 plan. The main difference is that you also can use it to fund K-12 educational costs, including private schools.
If you’re a big saver or have a high income, though, a Coverdell ESA can be limiting. You can contribute only $2,000 per year to an account. Plus, your modified adjusted gross income can’t be higher than $110,000 to establish an account (or $220,000 if you file a joint tax return).
A Roth IRA sounds like a great place to save for retirement, not college. But depending on your situation, you could do both. That’s because the IRS allows you to withdraw money for college expenses tax-free and penalty-free. The only requirement is that the account is at least five years old.
Roth IRA earnings also grow tax-free, so you’re on par with a 529 plan’s federal tax advantages. There’s no state tax benefit for Roth IRAs, though, so a Roth IRA is a great option if your state doesn’t offer a state tax incentive with its 529 college savings plan.
Plus, if your child doesn’t go to college, you can keep the money for your retirement savings instead.
The main drawback to a Roth IRA is its income and contribution limits. You can contribute up to $5,500 per year, but you can’t contribute at all if your income is above a certain level, depending on your tax filing status.
Taxable investment account
If you want maximum flexibility with your money, consider a taxable investment account. There aren’t any tax incentives, so your return on investment might be a little lower. But you’re not required to use the money you place in it for college expenses.
Should you save with a 529 plan?
When it comes to saving for college, there’s no one-size-fits-all answer. For many parents, 529 plans are a great way to save for education expenses while also enjoying state tax incentives. But others might find 529 plans limiting in terms of what they provide.
For me, flexibility is paramount, so I’m experimenting with a mixture of a 529 plan and a taxable investment account.
Always review several 529 plans and alternatives to determine which choice is best for you. Consider the tax benefits, fees, and flexibility of each option. Then, decide what your top priorities are.
And don’t forget: The sooner you start saving, the better. So don’t delay.
Interested in refinancing student loans?Here are the top 6 lenders of 2018!
|Lender||Variable APR||Eligible Degrees|
|Check out the testimonials and our in-depth reviews!
1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 6.97% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 6.30% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at email@example.com, or call 888-601-2801 for more information on ourstudent loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
APR stands for “Annual Percentage Rate.” Rates listed include a 0.25% EFT discount, for automatic payments made from a checking or savings account. Interest rates as of 11/8/2018. Rates subject to change.
Variable rate options consist of a range from 3.27% per year to 6.09% per year for a 5-year term, 4.64% per year to 6.14% per year for a 7-year term, 4.69% per year to 6.19% per year for a 10-year term, 4.94% per year to 6.44% per year for a 15-year term, or 5.19% per year to 6.69% per year for a 20-year term, with no origination fees. APR is subject to increase after consummation. The variable interest rate will change on the first day of every month (“Change Date”) if the Current Index changes. The variable interest rates are based on a Current Index, which is the 1-month London Interbank Offered Rate (LIBOR) (currency in US dollars), as published on The Wall Street Journal’s website. The variable interest rates and Annual Percentage Rate (APR) will increase or decrease when the 1-month LIBOR index changes. The variable interest rates are calculated by adding a margin ranging from 0.98% to 3.80% for the 5-year term loan, 2.35% to 3.85% for the 7-year term loan, 2.40% to 3.90% for the 10-year term loan, 2.65% to 4.15% for the 15-year term loan, and 2.90% to 4.40% for the 20-year term loan, respectively, to the 1-month LIBOR index published on the 25th day of each month immediately preceding each “Change Date,” as defined above, rounded to two decimal places, with no origination fees. If the 25th day of the month is not a business day or is a US federal holiday, the reference date will be the most recent date preceding the 25th day of the month that is a business day. The monthly payment for a sample $10,000 loan at a range of 3.27% per year to 6.09% per year for a 5-year term would be from $180.89 to $193.75. The monthly payment for a sample $10,000 loan at a range of 4.64% per year to 6.14% per year for a 7-year term would be from $139.65 to $146.76. The monthly payment for a sample $10,000 loan at a range of 4.69% per year to 6.19% per year for a 10-year term would be from $104.56 to $111.98. The monthly payment for a sample $10,000 loan at a range of 4.94% per year to 6.44% per year for a 15-year term would be from $78.77 to $86.78. The monthly payment for a sample $10,000 loan at a range of 5.19% per year to 6.69% per year for a 20-year term would be from $67.05 to $75.68.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown.
All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.28% effective October 10, 2018.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.47% – 6.99%3||Undergrad & Graduate|
|2.47% – 6.30%1||Undergrad & Graduate|
|2.51% – 8.09%4||Undergrad & Graduate|
|3.02% – 6.44%2||Undergrad & Graduate|
|2.69% – 7.21%5||Undergrad & Graduate|
|2.79% – 8.39%6||Undergrad & Graduate|