Saving for a child before you even have one might seem like an impossibility, but it’s actually not. Thanks to a savings plan called a 529, you can start saving for your future child’s education costs well in advance of actually having any rugrats of your own. And guess what! These plans can even help you save on your tax bill.
Last year, The Washington Post reported that college costs are rising faster than financial aid can keep up. The burden of paying for college is falling more and more on the shoulders of individual families.
Since college is one of the most expensive purchases most people make, the earlier you can start saving, the better off you’ll be. Starting early means time is on your side; if you start saving for a child’s college expenses 25 years before they start school you’ll have a quarter of a century worth of interest built up.
What Is a 529 Plan?
A Section 529 plan is a higher education savings plan organized and operated by each of the 50 states (as well as the District of Columbia). You can open one at any time, including before whoever may use it is even born.
Nor are you limited to opening a 529 in the state you live in; you can open one in any state you want. For example, if your home state has fees but a neighboring one doesn’t, you can open your 529 in the fee-free state. You’ll skip the fees, earn the interest and make yourself even more money.
529 earnings are not subject to federal tax, and you won’t owe Uncle Sam when you take money out of the account. Though plans vary from state to state, earnings are also generally not subject to state tax when used for qualifying education expenses like tuition, books or room and board. Two-thirds of U.S. states also offer a deduction or credit against their own income tax for contributions to the home-state plan. (There’s no federal income tax deduction for these plans.) There’s also no limit on how many plans you can open, so you can start one for each child you have (or plan on having).
What’s more, you can open a plan in your name today and change it when your child needs access to the funds. So you don’t have to open the account in your unborn child’s name for them to use the money someday. All you’ll need to do is change the beneficiary on the account.
How Do I Open up a 529?
To open up a 529, you’ll need to go through either your state’s sponsored administrator or a private advisor.
Each state selects a brokerage administrator to be in charge of its 529 plans and work with investors. You deal with the administrator, not the state directly.
Or you can open a plan with a private advisor like Wealthfront. Often, these plans will be cheaper, but they may offer less guidance than the state-selected plans. You’ll need to form an account with a private advisor, but you can do so from the comfort of your own couch. Nothing wrong with that! (In fact, here at Investor Junkie we like Wealthfront so much we’ve named it the top robo-advisor.)
The Two Types of 529 Plans
There are two types of 529 plans: prepaid plans and investment plans:
Prepaid Plans: With prepaid plans, you can pay for a stretch of tuition ahead of time. It’s usually a year, but plans can work with you on how long you want to pay for. By prepaying, you effectively lock in a tuition rate for your child’s future education. Tuition price changes won’t affect you. Unfortunately, not all states offer prepaid plans, and you can use the money only for tuition (not room and board, books, etc.).
Investment Plans: With investment plans, you decide how you want to invest your money and have the discretion to spend the total amount (earnings and principal) however you want. You can use it for books, tuition, room and board — whatever related costs you need it for.
(Note: It is possible to use 529 funds for non-educational needs if absolutely necessary. If you need the money for something like medical bills, you’ll pay income tax rates on the gains, plus a 10% penalty to the government. If something else happens, like your child wins a scholarship, becomes disabled or passes away, you can withdraw money out without paying any penalties.)
Some employers offer 529 plans as part of their benefits package. Check with your employer to see if that’s the case for you.
However, no matter what type of plan you choose or how you get it, keep an eye on fees; annual and investment fees can be big money drains.
Starting a 529 plan for children you don’t even have yet is a great way to give your future kids a huge leg up on paying for college. And starting early means you can put away money in smaller chunks over time. Start by seeing what the terms of your state-sponsored plan are, and then compare them to private advisors.
If you decide to open up a 529, the money will be there for your child when they need it. Plus, you’ll have peace of mind knowing you can pay for whatever degree they want to get.