How To Fit 529 Plans Into Your College Savings Strategy

Saving money for college may not always be a top priority, especially if home, utility and car payments, along with putting food on the table, need to come first. But designated college savings plans, like 529 plans, can be a smart option if you want to start saving for a child’s education early—and take advantage of tax incentives.

Here’s how to fit a 529 plan into your college savings strategy.

What Is a 529 Plan?

A 529 plan is a savings plan that lets families set tax-deferred money aside for a child’s future education costs. 529 plans were created to cover higher education expenses, but they can also be used to pay for some K-12 costs in certain states, with limitations that depend on the plan. Every state offers its own 529 plan, and some private colleges and universities do, too.

There are two types of 529 plans:

Prepaid Tuition Plans

A prepaid tuition 529 plan lets you prepay college tuition costs at today’s prices. It’s usually reserved for in-state public colleges and universities. While tuition and fees can be prepaid, room and board cannot. These plans aren’t guaranteed by the federal government, but some states back their plans and promise to provide funding if the program encounters financial issues. Not all colleges and universities participate, which could also limit where your child can attend school.

Savings Plans

A 529 savings plan lets you put after-tax dollars in investments like mutual funds and exchange traded funds (ETFs), and your money then grows tax-free. The earlier you open a 529 savings account, the longer the funds have to grow. These plans are usually sponsored by state governments and managed by financial services firms. Most states don’t require you to attend in-state public colleges using 529 money. Since this is an investment account, it does carry some risk, and there’s a chance you could lose money.

Who Can Benefit From Saving in a 529 Plan?

College isn’t getting any cheaper. According to a report from the College Board, the average cost of tuition and fees at a four-year public university in 2019-20 was $10,440. Over four years, that’s more than $41,000—and that doesn’t include other costs, like books, room and board. If a student ends up taking an extra semester or year to complete a degree, that cost increases.

Most families can therefore benefit from 529 plans, which give your savings the opportunity to grow if you start early enough. Additionally, your earnings can grow tax-free, and your withdrawals are not taxed as long as you use the funds for qualifying college costs. If your child doesn’t use the money, you can transfer it to another relative (even yourself)—though the funds must be used for qualifying educational expenses.

A 529 plan might be right for you and your family if:

• You need a dedicated savings avenue. If you don’t think you’ll have enough cash on hand to pay for your child’s college when the time comes, you can save little by little throughout their childhood and teen years. The sooner you start and the more you diligently save, the less you’ll pay out of pocket come freshman year. In certain plans, funds may also be used for K-12 costs, like private or religious schools.
• You want to limit how much you and your child borrow in student loans. If you don’t want your child to fall into the student loan debt trap, a 529 plan can help you avoid borrowing college loans. Or, if your 529 money won’t cover all of your college costs, you can take out federal student loans only instead of having to turn to private student loans, too—which typically don’t have as many consumer protections as federal loans.
• You can afford the contributions. Like any investment account, the more you put into it, the more money you’ll have when the time comes to spend it. But if you have other pressing financial obligations, you may not be able to contribute to a college savings plan.

You’re not restricted to saving in a 529 plan within your state. You can also choose a plan in a state that your child doesn’t attend school in. But take a look at the tax benefits in your state to make sure you’re not giving up valuable perks. Check out Morningstar’s 529 plan ratings to explore various plans’ features.