How To Pay for College Using a 529 Plan

Saving for college is a common experience for parents and students, but there are multiple ways to make college more affordable. Some students choose to use a program called a 529 plan.

In this article, we'll define what a 529 plan is and detail how students can take advantage of a 529 to cover college expenses.

What Is a 529 Plan?

A 529 plan is a tax-advantaged savings account, like an individual retirement account (IRA) or Roth IRA, that allows a person or family to make contributions over time. These funds can then be withdrawn to make payments at eligible educational institutions.

Like an IRA, qualified withdrawals are protected from federal income tax, meaning you won't have to pay additional taxes when you take out the funds.

Students can use a 529 plan to save money on tuition and pay for college costs; however, withdrawals aren't as simple as using a credit card or a checking account. You need to know the difference between qualified and non-qualified expenses, how to make tax-free withdrawals, and the impact a 529 plan could have on your Free Application For Federal Student Aid (FAFSA) form.

Steps for Paying for College With a 529 Plan

Getting a 529 plan is one of several ways high school students can start saving for college. To do so, you must follow multiple steps to make the most of it. Some factors to consider include the plan provider, contribution schedule, and expected tuition expenses.

Open a 529 College Savings Plan

Opening a 529 plan starts with finding the right plan administrator. Enrollment in different plans will have both advantages and disadvantages. Review the administrative fees and costs before signing up for any 529 plan, regardless of provider. Once you've selected a plan, you can open your account.

You can open a 529 plan for a student, even if you aren't their parent; however, if you're a grandparent or other relative, you might want to let their parents open the account. Anyone can contribute to a plan, but only the account owner can make financial decisions about investment and beneficiary status.

Contribute to the Plan

You can begin contributing as soon as your account is open. The IRS doesn't have a cap for contributions in a single calendar year, but individual state tax codes can be triggered by gifts over a certain amount. You should be able to learn more about your state's gift tax threshold from a tax professional or on your state government's website.

People can choose their contribution schedules; some elect to contribute parts of each paycheck to their plan, while others reinvest non-payment funds (i.e., bonuses and tax returns). Finding the contribution schedule that is best for your plan will help you grow your funds with consistent frequency.

Learn more: Does a 529 Plan Have Limitations?

Invest the Contributions

A 529 isn't a bank account; these plans work similarly to IRAs. Plan funds are allocated based on a chosen investment portfolio. Meeting with a financial advisor can help you look at your investment options and choose the right ones for your plan.

Certain investment strategies will be better at different stages of the plan's life. As you get closer to making withdrawals, you will probably want to take a more conservative approach to funds, while more risks can be taken at the start of a plan's life cycle.

Monitor and Adjust Investments

529 plan investments shouldn't be left idle. The account owner can change investment amounts or authorize a financial planner to change investments that will maximize returns on investment. You can also make changes to your portfolio to include assets, such as stocks, bonds, and commodities.

Maximize the Tax Benefits

Taxpayers have multiple benefits when it comes to 529 plans. The main tax benefits include tax-free withdrawals plus no accrued federal income tax. This means your savings can grow without an added tax on the amount. Tax-free contributions usually are limited to a flat amount or a percentage deduction.

Some states may allow for deductions, though this isn't available for federal taxes. Tax benefits may vary, depending on personal finances and other tax credits that are claimed, such as the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). Speak with a tax professional to see which benefits are available for you.

Learn more: Available Tax Credits for Education

Use Funds Wisely

Making the most of your 529 plan means allocating and withdrawing your funds wisely. First, ensure that you only withdraw your funds for qualified education expenses. In addition to the costs associated with a college education, like supplies and college tuition, 529 plans can be used for student loan debt repayment and even K-12 tuition at private elementary and high schools.

Qualified higher education expenses (QHEE) can also include costs associated with internships and apprenticeship programs if your beneficiary pursues a trade or vocational school instead of college.

FAQs About 529 College Savings Plans

Future college students and their families may have questions about how 529 plan funds affect things like income taxes and financial aid eligibility. Getting answers to questions about using your 529 plan to cover tuition bills and other college expenses is an important part of planning for higher education.

Can I Reimburse Myself From the 529 Plan for Prior Year Expenses?

There are conflicting answers regarding the best practices of reimbursing yourself for prior year expenses. The IRS hasn't set official guidelines preventing previous year reimbursements but there isn't explicit approval either. Before trying to use 529 plans to reimburse expenses from a prior year, make sure to discuss your reimbursement plan with a qualified tax professional.

Do I Need Receipts for 529 Expenses?

You should keep receipts or similar documentation for all 529-related withdrawals and expenses. The IRS or plan administrator might need you to verify that the withdrawal was used for a qualified higher education expense. If you can't prove that the expenses qualify, you could incur penalties and taxes on the amount withdrawn.

Can I Use Funds from a 529 Plan To Pay for College Application Fees?

College application fees are covered by 529 plans. 529 plans can be used for all qualified higher education expenses, not just tuition. Application fees are considered QHEEs because they are required for admittance to a college.

How Do Scholarships Impact 529 Plan Withdrawals?

You can withdraw your funds for QHEEs, even with scholarship funds. A 529 plan can be considered an asset, which is included in your FAFSA forms. Financial assets like a 529 plan can reduce eligibility for scholarships, grants, and other programs, like the American Opportunity Tax Credit.