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This article explains how to use a tax-advantaged 529 College Savings Plan. According to the College Board and Investopia, the average annual in-state tuition at a public four-year university tops $20,000. Not to mention, that the cost climbs to more than $45,000 per year at a four-year private university.

In other words, the average student now graduates with approximately $30,000 in student debt. It is estimated that around 70 % of graduates leave college with some level of student debt. The Federal Reserve has said that Americans now owe more than $1.4 trillion in student loans. In short, these numbers are jaw dropping.

What is a 529 Plan


Research from Citizens Financial Group suggests that 60% of student-debt-borrowers expect to pay off their loans in their 40’s.  Furthermore, the research by individual states support these findings. 

One study finds that it takes the average graduate of a Wisconsin university 19.7 years to pay off a bachelor’s degree. Moreover, it will take 23 years to pay off a graduate degree. One question we need to ask ourselves is, “aren’t we going to school to earn more?”.

Why is it that the cost of an education now puts people into such large amounts of debt? In retrospect, $30,000 is enough for a down payment on a house in many parts of the country.

Of course, education is important. This is why it is critical to save for college.

What is a 529 plan?

529 plan . Federal income tax rate

It is a tax-advantaged savings plan that is specifically used for future college or continuing education costs. Earnings from a 529 plan are exempt from federal income taxes.

Federal income taxes are calculated based on a percentage of your yearly income. Typically, federal income taxes can range from 10%-37%.

Keeping as much of your hard earned money as possible is critical! Why give money away to the government, when it can go into a savings account?!?


What is Covered Under a 529 Plan?

  • Colleges
  • Universities
  • Vocational schools
  • Other post-secondary educational institutions

There are Two Types of 529 Plans

  1. Prepaid Tuition Plans: This kind of account allows the college saver or account holder to purchase credits with participating universities. Typically, public and in-state colleges participate in these programs. This savings plan allows you to use the credits for future tuition and mandatory fees. Another benefit is that you get to purchase the credits based on the cost at current prices.
  2. College Savings Plans: This savings plan is an investment account that is used for higher education expenses. In this case, the money can be used for tuition, mandatory fees, and room and board. Typically, withdrawals from the college savings account can be used at any college or university. Another benefit is that the funds in the account can be invested in a wide range of portfolio options. This including various mutual and exchange-traded funds (ETF).

***Note: The prepaid tuition plan does not cover future room and board costs.


How Does Investing in a 529 Plan Affect Federal and State Income Taxes? 

Contributions: Yet another benefit is that many states offer tax benefits for contributions to a 529 plan. These benefits may include deducting contributions from state income taxes or matching grants. Accordingly, be sure to research the state that you are living in, and what option benefits they have for the 529 plans.

Withdrawals: If 529 account withdrawals are not used for qualified higher education expenses, they will be subject to taxes and a penalty. If you took state and federal income tax deductions, then you will be required to pay taxes on those funds. Additionally, you will be hit with a 10% federal tax penalty on the earnings.*** Always consult a tax adviser, as I am not a CPA**

What Expenses Can and Can Not Be Paid for by a 529 Plan?

According to the IRS, eligible expenses include:

  • Desktop computers
  • Laptops
  • Any device controlled by the computer (such as a printer).
  • Internet service 
  • Textbooks

Unfortunately, any additional study material that is not included on the syllabus may not be covered.

The student should keep a copy of the syllabus with their textbook receipts in a file labeled “529 plan expenses”. Of course, the student should get in the habit of maintaining good records.

Keeping good financial records is a great life skill and will help greatly should the IRS come knocking.

Do not use the funds for lifestyle expenses. Examples of lifestyle expense are furniture for an apartment (big screen TV, couch, sofa or kitchen table) and cell phone bills. None of these expenses are deemed as necessary to attend college.

***Remember: Keep separate receipts for money spent by a 529 distribution. i.e don’t buy school T-shirts or other school team gear from the bookstore on the same receipt.

Does Investing in a 529 Plan Impact Financial Aid Eligibility?

Yes, investing in a 529 plan could impact a student’s eligibility to receive need-based financial aid. It is generally a better idea to plan for the future, than to hope that the government will be able to assist you through college.

Financial aid plans are subject to change, meaning that you could qualify one year but not the next. Most aid programs are also dependent on obtaining a certain GPA minimum, and if the student dips below the required minimum they will lose their financial aid package.

Options for Withdrawing Money From a 529 Plan:

There are three distribution options available:

  1. Send a Check Straight to the School
  2. Sending a Check to Yourself – (typically this is the parent of the college attendee)
  3. Sending a Check to Your Beneficiary (the student)

529 plan loan balance

Planning is an important part of preparing for the future. The sooner you start, the more time you will have to save for college. If you decide to go with the savings plan, the sooner you start saving and investing the more time the money will have to compound! If there is a topic you are interested in knowing more about, let me know by commenting below!


Photo credit

Federal income tax brackets

Borrowers by age group

Loan amount  by age group

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Lynzee Lai

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