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It's pretty much common knowledge that the earlier you start saving for a big expense, like college, the better off you'll be in the long run — and the less likelihood you'll need to rely on additional financing like student loans.
For parents and guardians who want to help fund their child's higher education, however, the best place to save that money isn't necessarily your typical savings or investment account.
While a high-yield savings or investment account offer more flexibility for parents looking to save, neither come with tax advantages that 529 college savings plans do. With a 529 plan, your contributions grow tax free, so it's especially beneficial if you start contributing early. Plus, withdrawals made later on for qualified education expenses (things like tuition and books) are also non-taxable.
A 529 college savings plan allows savers to stash away money specifically to fund a college education and offers tax-deferred growth and tax-free distributions for qualified education expenses. As 529s are state-sponsored savings plans, some states will offer their own income tax deduction, or tax credit, in the year you make a 529 contribution, up to certain limits.
When choosing a 529 plan, you're not limited to your own state's plan, but you may want to first see what it offers residents before shopping around. Some states like Idaho and New York have additional incentives for their residents.
"Many states require you to contribute to the state-specific 529 plan in order to take advantage of benefits," Borglum says. "While this doesn't hinder your child's ability to attend an out-of-state school, you don't want to leave free money on the table."
Money saved in a 529 plan is considered a parent asset on the FAFSA® form and has minimum impact on a student's eligibility for federal aid.
Because a 529 plan is primarily used to save for the cost of higher education, it's difficult to use those funds effectively toward anything else. This is one reason why some parents may be hesitant to open a 529.
But Borglum argues that 529 plans do offer some flexibility, so parents shouldn't worry too much about their funds going unused.
"You can even use the accounts to pay for up to $10,000 per year in tuition for K-12 schools," Borglum says. This annual $10,000 threshold spend applies to elementary, middle or high school tuition. Plus, $10,000 of your 529 plan can go toward student loan payments. You can also change the account's beneficiary to a family member, such as a sibling, niece or nephew, for their own qualified education expense use. You could even use the money to fund your own higher education endeavors.
In the worst-case scenario, you could distribute the funds for non-educational reasons and simply pay tax on the growth, plus a 10% penalty on the earnings, Borglum explains. "Many times, this impact isn't too severe, especially if the beneficiary is in a low tax bracket," she explains.
Borglum adds that she even uses clients' 529 accounts at times to transfer family wealth to a younger generation, whether or not the intent is to use for education.
There are contribution limits of up to $15,000 per year per beneficiary before you need to worry about paying gift taxes. But individual donors also have the option to front-load up to five years of gift transfers ($75,000 total) all at once. This makes it easy to transfer a grandparent's estate, if they were the donor, to a younger generation, while also maximizing the compounded growth potential early on.
Now that you've decided a 529 plan is the most effective way to start saving up for your kid's college education, your next step is choosing one.
Select's list of the best 529 college savings plans is a good place to begin shopping around. Our selections all offer the lowest fees and widest range of investment options for saving up for your kid's higher education. Here are our top picks:
- my529 (Utah)
- Bright Start College Savings Program (Illinois)
- CollegeAdvantage (Ohio)
- Michigan Education Savings Program
- ScholarShare 529 (California)
You can read our methodology to learn how we selected the best 529 plans.
To determine which 529 plans offered the best underlying investments, low fees and a variety of investment choices, Select analyzed dozens of offerings and narrowed it down to a list of 10 finalists. We looked at plans with offerings from reputable companies and investment managers and a variety of options to help the investor meet their goals. We didn't evaluate 529 plans based on advantages (such as lower fees) for in-state residents or prepaid college plans.
We focused on the following features when comparing the best 529 plans:
- Management fees: The plans on our list offer some of the lowest management fees, important since these fees can affect your annual balance. Even a small fraction of a percent in fees can mean thousands of dollars in savings for the investor.
- Investment returns: Past results do not guarantee future performance of any investment. However, seeing historical patterns of returns may indicate the plan manager is doing their job well. We looked at returns over a five-year time period.
- Fund expenses: Aside from management fees, we chose plans offering the lowest maintenance fees for their underlying funds. We looked at 529 plans offering more passive types of securities like index funds, with the expense ratio being a major deciding factor. These costs also affect the amount investors will be able to save.
- Investment options: Having more choices means that parents and guardians can decide how involved they want to be when selecting their portfolio. We looked at 529 plans offering more hands-off choices such as age-based portfolios as well as individual funds.
Each state's 529 plan may have different minimum contribution amounts. Some may not have minimum contribution amounts but do for automatic contributions, such as payroll deductions. Each state also imposes its own cumulative contribution limit.