The Best Way to Fund College Education: Intro to 529 Plans

Of all the options available for funding your children’s college, 529 plans are by far the most popular and—in many cases—the best option.

In a nutshell, 529 college savings plans are state sponsored, tax-advantaged accounts used specifically for education expenses. Here’s why these plans are beneficial, and how you can best leverage them to your family’s benefit.

1. They’re available to almost anyone—yourself included

To open an account, you must be 18 in most states. Most commonly, a parent opens the account with her child as the beneficiary, but grandparents and others may also open them. In most states, nearly anyone can contribute to the plan, regardless of plan ownership. However, be sure to verify that your specific state allows for this before making any external contributions.

You can probably see the benefit already: you open an account for a son or daughter, and invite grandparents, family members, and any others invested in your child's success to contribute. 

It’s also possible to open a 529 for yourself, or any other party—related or not. Because of the tax deferral on investment income this plan offers, you (or the recipient) will reap the largest benefit if you have a relatively long time horizon.

Plus, if your state allows a tax deduction for your 529 contributions, you’ll receive a potential discount on college expenses, because that contribution amount would reduce your taxable income for state income tax purposes.

2. They offer tax benefits

A 529 plan provides tax benefits in two ways. First, the sponsoring state may offer an income tax deduction equal to the maximum contribution. (For information on income tax deductions by state, savingforcollege.com has great resources).

You should also be on the lookout for states that have reciprocity, meaning the state allows a deduction to any 529 plan—not just the contribution made to your resident state’s plan.

Secondly, you are exempt from paying Federal taxes on the investment earnings of your 529 plan. That means that your assets will grow tax-free while they remain in the plan. And, as long as you end up using the account balance for qualified education expenses, you’ll never pay tax on the amounts contributed or growth within the account.

3. Time works in your favor

You can begin saving for your children’s education even before you have them by opening an account for yourself as the beneficiary, and then switching it to your child later. This can be a good tactic if you feel you have excess cash to contribute now (above your retirement savings responsibilities) but are afraid money will be tighter when you have a child.

The longer you wait to open a 529 plan, the more dollars you will have to put in to fund the same amount of tuition—so it pays to start early. That said, make sure you always prioritize your retirement planning first, because there are multiple options for funding college, but only one for retirement: the amount you’ve accumulated up to that point.