June 4, 2020 By Jeff Rose
How to Use a 529 Plan to Pay for College
A college education may be essential for many jobs, but higher education is not always affordable. College Board figures show that average tuition and fees for the 2019-2020 school year worked out to $10,440 for public, four-year schools in-state, while one year of tuition at a private, nonprofit four-year school worked out to $36,880. Tuition at public, two-year schools, or community colleges worked out to a much more reasonable $3,730 per year, but it’s important to note that these figures only include tuition and fees and not room and board.
At the end of the day, this means that college can cost a lot of money. Expenses can add up if you don’t qualify for merit-based aid and if your income is too high to qualify for other types of financial assistance. With costs growing each year, it is best to plan early and think about how you’ll help finance your child’s college education. You may have even opened a 529 savings plan to cover educational costs. But now you’re wondering, “How do you use a 529 plan to pay for college?”
What is a 529 College Savings Plan?
A 529 plan is a tax-advantaged savings plan that makes it financially beneficial to start saving for college while your kids are still young. These plans are typically sponsored by states, state agencies, and some educational institutions, although they all work somewhat the same. Also note that some prepaid college plans count as 529 plans, although these plans typically have you prepay and lock in rates at specific schools.
A recent survey from College Ave Student Loans conducted by Barnes & Noble College Insights showed that 71% of responding parents of college students were saving for their children’s college education and that some had up to $40,000 stashed away. Many of them also stated they use a college savings account for this purpose instead of traditional checking or savings or an investment account.
With a college savings plan, you can add money every year and watch it grow tax-free, then you can take distributions without paying taxes when you use the money to cover eligible expenses associated with higher education. Many 529 college savings plans also let you invest your funds in underlying investments that can help them grow over time. However, there are fees associated with 529 plans that you should know about, particularly because fees will eat away at your returns.
How Do You Use 529 Savings Funds to Pay for School?
Adding money to a 529 plan is easy once you take the time to open an eligible account. Parents and other family members can easily contribute to it. But how exactly do you use the money for school? This process is rather simple as well.
To use 529 plan money for college expenses, you need only to set up a distribution from your 529 plan account into your own bank account. The money you take out can then be used for eligible college-related higher education expenses, which may be broader than you think.
If you use the money for non-college expenses, then a 10% penalty applies. Also, keep in mind that you have to spend the money on college expenses during the year you took the distribution. And while the 529 plan administrator may not require proof of how you spend the money, you’ll need to keep excellent records in case the Internal Revenue Service (IRS) follows up.
You may be wondering if you should spend your 529 funds all upfront, or if you should spend only part of your savings each year your child is in school. That’s totally up to you, and it may depend on how much money you have saved overall.
In my opinion, it makes sense to spread your 529 college savings over the years your dependent is pursuing a degree if at all possible. That way, you can use your savings to fill the gaps after other aid is accounted for each year.
If you have more than one child, you may also want to spread out your savings over each of their college careers. Ideally, you would earmark a specific amount of money for each of them then cover as much of their tuition and fees as you possibly can each year.
Which College Expenses are Considered Eligible?
Interestingly, the Tax Cuts and Jobs Act of 2017 made it possible for parents to use 529 funds to pay for K-12 private school tuition. The limit on this option is $10,000 per student, per year but it can still be helpful if you have kids in private schools.
Other educational expenses that you can use 529 plan funds for include:
- tuition and school fees,
- books and supplies,
- computers and internet access,
- room and board (or rent and groceries),
- transportation and travel costs,
- and college-related testing fees
There are other expenses that could qualify, but you’ll want to check with the institution that you have your 529 plan with.
As of 2019, you can also use up to $10,000 in 529 plans per beneficiary to pay off student loans. This $10,000 limit is per beneficiary and per lifetime, so a family with three kids on a 529 plan or separate 529 plans could repay $30,000 in total student loans with this option.
What are the Tax Benefits of 529 Plans?
We already mentioned how 529 plans were tax-advantaged, but what does that mean? For the most part, this means that the money you add to your account isn’t taxable like money you add to a brokerage account or investment account. Your funds will grow tax-free over time, which can help them grow and compound faster. And you won’t have to pay taxes on your 529 funds when you use them for eligible higher education expenses.
Some states also offer tax benefits upfront when you contribute to a 529 plan. For example, the state of Indiana offers a 20% tax credit good for up to $1,000 on the first $5,000 you contribute to a 529 plan each year.
Other states have their own tax benefits for 529 plans, but they vary a lot. If you want to see what your benefits are depending on where you live, you should check with your state tax authority to see whether you qualify for a state tax credit for contributions or some other type of benefit when you contribute.
College savings plans don’t make college less expensive, but they do take the sting out of having to cover higher education expenses all at once. If you start saving now and save for college for a decade or longer, your money has the potential to grow fast enough to keep up with the rising costs of higher education.
You can easily take out student loans to cover any gaps, but having some money set aside for college is priceless. A 529 plan can make saving money a little easier thanks to the tax benefits, but only if you get started.
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