How do you plan to fund your children's education? According to the 2017 Report from Sallie Mae, How America Pays for College, you are probably counting on scholarships and grants.
Sallie Mae finds that reliance on scholarships/grants is the highest in a decade, while college savings is on the decline. Savings covers less than one-quarter of collegiate funding for the typical family. As a result, one of the strongest educational savings programs – 529 plans – is being underutilized.
Only 13% of families used a 529 plan during the 2016-17 school year. That's the lowest number in the past five years and down significantly from the 17% peak in the 2013-2014 school year.
Parents may be having difficulty saving enough to use these programs – but it's possible that parents don't see the overall advantages of a 529 program or don't fully understand how it works.
Most 529 programs are run by states and act as a sort of educational Roth IRA. You may open an account in any state. Withdrawals from state-run 529 programs do not have to be used within that state – you can live in one state, have a 529 program in another state, and fund a college education in a third. (One 529 variation is college-specific – used to prepay tuition at a particular university.)
529 plans are funded with post-tax dollars. Earnings grow free of federal taxes, and withdrawals are tax-free as long as they are used to pay for qualified educational expenses, including at many vocational and technical schools. You can start a 529 plan regardless of your income, and anyone is welcome to contribute to the plan.
529s offer unique flexibility. You can transfer the account to a different sibling if the intended recipient earns a full ride or chooses not to attend college at all. You can transfer it to a different relative, a friend, or even use it yourself if you decide to further your education.
If you're planning on seeking financial aid, 529 plans may actually help. When you fill out the Free Application for Federal Student Aid (FAFSA), you disclose both parental and student assets. The assets in custodial savings accounts reduce a student's aid package by 20% of the account's value. As a parental asset, 529s reduce aid packages by 5.64% at most. If the 529 owner is a grandparent or other relative, the account is not reported on the FAFSA at all.
In case of emergency, you can withdraw funds for non-educational purposes – but you'll pay tax on any earnings and a 10% early withdrawal penalty.
Thanks to the Tax Cuts and Jobs Act, 529 funds may be used for qualified K-12 educational expenses as well. Unless you start a 529 program extremely early, you undercut one of the main advantages – the ability to generate tax-free earnings. The earlier you withdraw, the lower your tax-free earnings. However, you may be able to save on state taxes by drawing school tuitions from a 529 program instead of paying tuition directly.
Sold on the idea? Don't automatically stick with your state program, as terms, limits, and investment options vary by state. Compare 529 programs to find the best terms for your situation.
A 529 savings plan can play a valuable role in your educational savings strategy, offering you an excellent combination of tax advantages and flexibility. Consider a 529 as you map out your children's educational funding options. Don't let a lack of funds limit your children's college choices – or keep them from attending college at all.
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