As I just mentioned 529 plans are designed for college savings. They even have a legal name (who knew?). They are "qualified tuition plans" (QTP) according to the U.S Securities and Exchange Commission. They get their name because they are authorized by Section 529 of the IRS code. Good to know information in case I am playing Jeopardy someday.
An account holder opens a 529 plan and designates a beneficiary. For example Mom & Dad open a 529 account for Junior. Junior is the beneficiary. Mom & Dad hope that this funding will pay for college expenses. Junior can use this 529 plan in any state at any accredited institution. That may not be the case with the states' prepaid tuition plan, which is different than a 529 plan. Grandparents can even open an account for Junior and contribute.
One of the beautiful things about 529 plans is that the money belongs to the account holder. They can re-designate the money to a new beneficiary whenever they choose. For example, Junior has decided to take some time to "find himself" before beginning his college journey. The account holder can then designate the money to Janie, Junior's sister.
Or let say you get lucky and your kids get full ride scholarships, decide not to go to college, enlist in the military, or join the seminary or convent, then the account holder can use that money for their own higher education. If the money is NOT used for higher education then it is taxed and the account holder gets hit with a 10% penalty. This is the part of the 529 plan that I don't like.
You can have 529 plans in different states also. There is no restriction. You can live in Maine and open up an account in New Mexico and your beneficiary goes to college in Florida. And anyone can contribute to a 529 plan. The amount contributed is not deductible on your federal return but some states may allow for deductions for contributions.
- According to the IRS: "Contributions to a QTP on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary."
529 plans grow tax-free as long as the money is used for qualified higher education costs, which include tuition, room, board, fees, books, and supplies.
Here is an example I borrowed from SavingForCollege.com of what will happen when it comes time to fill out the FAFSA (Free Application for Federal Student Aid):
Here is a simplified example of how this all works:
You file the FAFSA aid application when your child is a senior in high school. Let's say you have a 529 savings account with $20,000 in it, of which $10,000 represents your original contribution and $10,000 is earnings.
Year 1: Your child's eligibility for federal financial aid this year will decrease by no more than 5.64% of the account value, or $1,128 ($20,000 x 5.64%). Assume there is no further appreciation in the account and you withdraw $5,000 in the fall to pay for the first semester college bills.
Year 2: You have $15,000 left in the account when your child applies for aid for sophomore year, and it will again be assessed up to 5.64% of the account value or $846 ($15,000 x 5.64%). The $5,000 withdrawal brought $2,500 of excluded earnings with it, but as indicated above, none of the withdrawal is counted as financial aid income.
The federal aid formula is more complicated than what is described here, but this gives you a general idea of how to calculate impact.
Be Prepared!
Sound complicated? It is. And we are only talking about the federal financial aid rules here -- each school can (and most will) set its own rules when handing out its own need-based scholarships, and many schools are starting to adjust awards when they discover 529 accounts in the family. Also consider that the federal financial aid rules are subject to frequent change. Finally, remember that most financial aid comes in the form of loans, not grants, and so you end up paying it back anyway.
Sometimes I feel like we are penalized for doing the right thing by saving for college. That is one of the reasons we are not interested any longer. We have done this before with our oldest. She never qualified for even a subsidized student loan because of the income and the savings.
- A subsidized student loan is when you aren't charged interest while you are in school at least at least half time.
- A subsidized student loan means the clock starts ticking for interest accrual when payment is made to the school.
I hope this has helped a bit. The request was vague on 529 plans, but if there is something more indepth that is needed leave me a comment and I will do my best to accommodate.
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