Published: March 2015
Has uncertainty about the rules of 529 college savings plan discouraged you from starting one? These plans can seem complex, since they involve both federal and state tax implications. However, many parents' confusion about the plans stems from simple misunderstandings. Read on to educate yourself about common plan questions, and get solid answers.
Truth: This isn't a requirement, says the College Savings Plans Network — which is fortunate, since many parents have no idea where their child will end up attending school.
One reason many people have questions about where 529 funds can be used is that there are two types of 529 plans: college savings plans (described here) and prepaid in-state tuition plans. Prepaid plans allow you to pay for future in-state tuition at today's prices but may require use of the funds in your home state, according to FinAid.org.
According to the Internal Revenue Service (IRS), you can use 529 college savings plan funds for qualified tuition and expenses (fees, books, room and board) at eligible schools in any state, regardless of where the plan is registered.
Truth: You're free to invest in any state's 529 plan, says the IRS; most of them don't require you to be a state resident.
You might want to compare several different states' plans before choosing one, since they may have different investing options, contribution minimums/limits, fees and performance rates.
One advantage to investing in your home state's plan is that you may be eligible for state tax deductions on your contributions. However, a few states offer "tax parity," meaning that you can deduct contributions to any state's 529 plan from your own state income tax, according to U.S. News.
Truth: Your child can attend an accredited public or private post-secondary school, and you can tap 529 account funds to pay for it, FinAid.org says. Eligible schools are those that participate in U.S. Department of Education aid programs, according to the IRS.
Many prepaid tuition plans (again, not to be confused with college savings plans) focus on in-state, public colleges and universities, FinAid.org notes
Truth:It probably won't matter as much as you think, says FinAid.org. Why? When you own a 529 plan (with your child as the beneficiary), it's considered a "parental asset." According to FinAid.org, parental assets count less in financial aid formulas than money owned by your child. Parental assets also matter less than your annual parental income.
Truth:You won't lose your contributions to the plan, according to the College Savings Plans Network. You have several options for recouping most or all of your invested money if your kid skips the college route.
You can make another family member the beneficiary of your 529 and use the money for that family member's college education, according to the IRS. You could also take college classes yourself and use the money for qualified educational expenses.
If neither of those options works for you, you can withdraw your own 529 contributions without penalty, according to the College Savings Plans Network. You'll simply owe state and federal taxes on the plan's earnings, along with a 10 percent penalty on the plan's earnings.