Let’s explore how to select and set up a 529 plan to help you make informed decisions about your child’s education savings in just a few steps.

1. Research and compare different 529 plans.

There are two types of 529 plans: prepaid tuition plans and college savings plans. Prepaid tuition plans allow you to pay for future college tuition at today’s rates, while college savings plans offer investment options to grow your savings over time. Compare the different plans available in your state as well as any out-of-state options that may offer additional benefits.

2. Consider your state’s tax advantages.

Many states offer tax benefits for residents who invest in their state’s 529 plan. These benefits may include deductions on your state income tax return, tax-free growth of your investment, and tax-free withdrawals for qualified education expenses. Be sure to check if your state offers such benefits and whether they are contingent upon investing in your state’s plan or if out-of-state plans are eligible as well.

3. Assess the investment options.

College savings plans offer a range of investment options, such as mutual funds, exchange-traded funds (ETFs), and age-based portfolios. Consider your risk tolerance, time horizon, and investment goals when selecting an investment option. If you aren’t as familiar with investing, it’s always a good idea to consult with a financial advisor.

4. Calculate the amount you need to save.

Determine how much you need to save for your child’s education. Consider factors such as the expected cost of tuition, room and board, books, and other expenses. Don’t forget to account for inflation and any potential scholarships or financial aid your child may receive.

5. Set up automatic contributions.

To make saving for your child’s education easier, set up automatic contributions to your 529 plan. This can be done through direct deposit or automatic transfer from your bank account. By automating your contributions, you can ensure that you’re consistent in saving for your child’s education without the hassle of remembering to make regular deposits.

6. Involve family and friends.

Many grandparents, relatives, and friends may want to contribute to your child’s education savings. Most 529 plans allow third-party contributions, making it easy for others to contribute to your child’s education fund. Also, as of 2023, when a grandparent owns the 529 account, there is no impact on the students applying for federal financial aid through FAFSA. Consider sharing the information and details about the plan with your loved ones so they can join in the effort to save for your child’s future.

7. Monitor and review your plan.

Regularly review your 529 plan and assess its performance. It is important to keep track of your savings and adjust your contributions or investment options as needed. As your child approaches college age, consider adjusting your investment strategy to become more conservative to protect your savings.

8. Understand 529 withdrawal penalties.

Withdrawals from 529 plans that are not used for qualified expenses may incur state penalties based on the individual's state of residence. Nonqualified withdrawals from a 529 plan can result in a 10% penalty and the investment gains will be subject to federal income taxes at the regular IRS rate. Consult a tax professional to review all potential penalties before taking money from your 529 plan.

New rules, introduced by the SECURE 2.0 Act, allow distributions from 529 plans to be transferred to Roth IRAs without tax or penalties, starting in 2024. Previously, unused funds in a 529 plan had limited options, which discouraged families from overfunding. The new rule includes a lifetime transfer maximum of $35,000, a requirement for the 529 accounts to exist for at least 15 years, and restrictions on transferring contributions or earnings made within the last 5 years. Additionally, the transfers are subject to the annual contribution limits of the Roth IRA, although there is no upper income constraint.

A 529 plan can be a great tool for saving for your child or grandchild’s education. By researching and comparing different plans, considering tax advantages, choosing appropriate investments, setting up automatic contributions, involving family and friends, and monitoring your plan, you can be well on your way to successfully saving for your child’s future college costs. 

Start early and stay consistent, and you will be giving your child a great head start in their educational journey.