Six 529 basics you need to know

While millions of people use 529 plans to save for their child's college education, a recent survey from Edward Jones found that a majority of Americans don’t know what a 529 plan is. Out of four potential options including a retirement savings plan, a form of life insurance and a low-cost health plan, only 29% could correctly identify a 529 plan as an education savings tool.

“529 plan is in reference to the Internal Revenue Code,” says Ric Edelman, executive chairman of Edelman Financial Services. “If you save money in a certain way under section 529, then those contributions can be earmarked for college. You pay no taxes on the profits every year. If you withdraw the money and use it to pay for college - tuition, room and board, books and so on - then all of the profits are completely tax-free.”

If you decide a 529 plan is right for you, Edelman says there are six important things consumers need to keep in mind.

Factor in the total cost of college

It’s expensive to attend college. The College Board says the average cost of a four-year private institution was $35,260 for the 2017-2018 school year. When education planning, Edelman says many parents make the mistake of thinking tuition is the full expense associated with college. He notes that half of the cost is room and board. Books alone can set you back thousands of dollars a year. If your child is attending college out of state, you’ll have to factor in hefty transportation expenses. Edelman says some parents also incorrectly believe that the cost of college is the freshman year times four.

“The average student takes six years to graduate not four,” he says. “Also, tuition increases are growing at such a rate that the child’s last year of college will probably be double the cost of their freshman year. So you need to be realistic about how much college is actually going to cost.”

Let it grow

If you are planning to have children, Edelman says you shouldn’t wait until the baby is born to start putting money into a 529 plan.

“The more you save, the more often you save, the sooner you save, the more wealth you are going to accumulate,” he says. “That is the best approach.”

Edelman says you will get the most benefit from your 529 plan if you invest it for an extended period of time. Congress made a change to the law this past year that allows consumers to also use money in a 529 plan for K-12 education. He says it’s a bad idea for parents to use the savings vehicle for early education.

“The only way to generate a lot of profit in the account is to leave the money there for a really long time,” he says. “You need to allow compounding to do its job. If you invest the money today and withdraw it in a few months, it’s not going to grow much in value. So there’s virtually no profit and virtually no tax benefit.” 

Take advantage of their flexibility

Are you worried about putting money into an account that might never be used? Edelman notes that the funds don’t have to be used only for the designated child. You can use it for any member of the family, the designated child’s brothers or sisters, cousins or even yourself. If your child doesn't use the account, he says odds are pretty good that someone else in the family will be able to take advantage of it in the future. 

Understand the difference

Did you know there are two different types of 529 plans? The 529 plan highlighted in this article is the one most people are familiar with. The college savings plan can be used for virtually every college in the country and almost any kind of college expense. However, there’s another type of 529 plan called the prepaid tuition plan. Edelman advises consumers against using those prepaid plans, as they are not as flexible. A majority of state prepaid tuition plans require that either you or your child are a resident of the state offering the plan. Most plans also don't cover other expenses, such as room and board.

“There is no certainty that your child will want to attend or even be admitted to an in-state school,” he says. “Plus it only covers tuition. These programs are not very fluid. They don’t provide that much of an economic benefit because you are only earning the rate of tuition inflation.”

Evaluate all of your savings resources

When saving for your child’s education, you may obtain money from different sources. In addition to a 529 plan, you may earn money from your job and put it into an account. Grandparents may have also saved for their grandchildren's education. When taking into account your child's current and future education needs, Edelman says parents need to figure out which bucket of money is best to use.

Use them for lifelong learning

Edelman says if you go back 20, 30 or 40 years ago, most people obtained a college degree in their early 20’s. After graduating from school, they would enter a career in a specific field and do that until they retired. He says those days are gone. Technology is changing everything. Edelman says the ability to learn everything you need to know to perform a job, is no longer possible in a 4 or 5 -year college experience. Most people will have to go back to school to learn new skills and remain marketable in the workforce. He says this is where 529 plans will continue to be useful.

“It’s not simply just about getting a college degree,” says Edelman. “It’s about lifelong learning. You are going to need to return to education in your 30s, 40s, 50s, even in your 60s. You need to be thinking not just about the cost of getting a degree at age 22, but the cost of paying for education throughout your working career.”

Linda Bell joined FOX Business Network (FBN) in 2014 as an assignment editor. She is an award-winning writer of business and financial content.  You can follow her on Twitter @lindanbell.