How Does My State’s 529 Plan Work?

According to the National Center for Education Statistics, the cost of college has doubled between the 1985–1986 and 2017–2018 academic years, so parents may find that their college savings don't go as far as they had hoped.

A 529 plan is a type of tax-advantaged savings account created specifically for the purpose of funding postsecondary education. There is one owner (who makes investment decisions and chooses the beneficiary) and one beneficiary associated with each 529 plan account.

It's possible for the account holder to also be the account's beneficiary. Any withdrawals made from a 529 plan to cover the beneficiary's qualified higher education costs or qualified elementary and secondary school tuition costs will be made free of federal income tax.

The 529 plan has proven to be a useful tool for many families, allowing them to save for higher education without sacrificing other priorities. Automated monthly contributions of $15 or $25 can be made to a 529 plan from a checking or savings account, making it much simpler to put money away for the future.

Table of contents

What is a 529 plan?

The purpose of the tax-advantaged 529 plan is to encourage people to save money for future college expenses. Section 529 of the Internal Revenue Code permits qualified tuition plans (also known as 529 plans) to be established and maintained by states, state agencies, or educational institutions.

Prepaid tuition plans and education savings plans are the two primary categories of 529 plans. Each of the fifty states plus DC offer some sort of 529 plan for college savings. Additionally, a consortium of private institutions has come together to offer a prepaid tuition programme.

In what ways do 529 plans and other education savings plans differ from prepaid tuition plans?

Education Savings Plans For the purpose of paying the beneficiary's future tuition and mandatory fees at the then-current rates, prepaid tuition plans allow savers or account holders to purchase units or credits at participating educational institutions (typically public and in-state). You can't prepay for elementary or secondary school tuition with most plans, and prepaid college plans won't let you cover room and board costs.

The majority of prepaid tuition plans have residency requirements for both the saver and the beneficiary because they are sponsored by state governments. The federal government will not back prepaid plans. Some state governments back their prepaid tuition plans with a guarantee, while others don't.

All or part of your prepaid tuition may be lost if the plan's sponsor experiences financial difficulties, 529 payroll deduction pre-tax. Another caveat is that the prepaid tuition plan might pay out less if the beneficiary doesn't go to a school that participates. The return on investment might be negligible, 529 payroll deduction pre-tax.

Plans for setting aside money for college. In order to prepare financially for a beneficiary's future qualified higher education expenses like tuition, mandatory fees, and room and board, a saver can open an investment account through an education savings plan, 529 payroll deduction pre-tax.

Withdrawals from 529 plans can be used for tuition at any accredited postsecondary institution, not just those in the United States. Up to $10,000 per year per beneficiary can be used to cover expenses at any accredited elementary or secondary school in the country, regardless of whether it is publicly funded or privately funded, 529 payroll deduction pre-tax.

Investors have access to many different types of investment portfolios, such as mutual fund and ETF portfolios and bank products that guarantee the investor's initial investment. Static fund portfolios and age-based portfolios are two other examples of this type of investment strategy (sometimes called target-date portfolios).

When the age of the beneficiary gets close to college age, the portfolio automatically shifts to a more conservative allocation of assets. When saving for K-12 education, your investment time horizon may be shorter than when saving for college, 529 payroll deduction pre-tax. If you need the money soon, you might not feel comfortable investing it in something riskier or more volatile. It's for these reasons that it's important to think about when you'll need the money from your investments.

Although all 529 plans are backed by state governments, only a subset of them require the saver and/or beneficiary to be legal residents of the state. Money put into 529 plans is not protected by any state government, 529 payroll deduction pre-tax.

Unlike principal-protected bank products, investments in mutual funds and ETFs made through a 529 plan are not backed by the federal government. Investments in 529 plans are subject to the same risks as any other type of investment, including the possibility of a loss of principal, 529 payroll deduction pre-tax.

Where can I find information about the costs associated with investing in a 529 plan?

A 529 plan's returns can be negatively impacted by fees and other costs, so familiarity with these factors is crucial. The fees and costs associated with a 529 plan will differ depending on the type of plan it is (either an education savings plan or prepaid tuition plan), whether the plan was sold through a broker or a direct sales channel, the type of investments in the plan, and other factors. Before investing, it's important to read the plan's offering circular and become familiar with the associated fees.

Education Savings Plans There may be an initial enrollment or application fee, as well as periodic administrative fees, for some prepaid tuition plans, 529 payroll deduction pre-tax.

Plans for setting aside money for college

Fees for enrollment/application processing, account maintenance, programme management, and asset management are all possible with education savings plans. The plan's state sponsor may collect some of these fees, while the plan manager may collect others, 529 payroll deduction pre-tax.

The asset management costs will vary with the type of investment strategy chosen. When purchasing a 529 plan through a broker, most investors will be subject to additional fees, such as sales loads or charges at the time of investment or redemption, as well as ongoing distribution fees, 529 payroll deduction pre-tax.

Fee Saving Tips

Investors in many states' 529 plans don't have to pay brokers' commissions because the plans are sold directly to consumers. In addition, if you have a sizable account balance, enrol in automatic contributions, or are a resident of the state that sponsors the 529 plan, you may be exempt from or eligible for a reduction in the plan's administrative or maintenance fees. Fee reductions or eliminations may be available from some 529 plans if the saver opts for paperless transactions or enrols online.

In what ways do federal and state income taxes change when money is put into a 529 plan?

Some investors may be eligible for preferential tax treatment if they use a 529 plan to put away money for their children's or grandchildren's education. The specific advantages depend on the state and the specific 529 plan, 529 payroll deduction pre-tax. There is also the possibility of changes to the federal and state laws that govern 529 plans. The tax implications of a 529 plan investment are complex, and you may want to seek the advice of a tax professional.

Contributions

Contributions to a 529 plan may be tax-deductible in a number of states. Contributions may be eligible for state income tax deductions, and matching grants may be available, but there may be conditions attached. Additionally, these advantages may be available only to savers who participate in a 529 plan offered by their state of residence, 529 payroll deduction pre-tax.

Withdrawals

Earnings in a 529 account are exempt from federal income tax and, in many cases, state income tax if the withdrawals are used for qualified higher education expenses or elementary and secondary school tuition, 529 payroll deduction pre-tax.

Withdrawals from a 529 plan that aren't used to pay for elementary or secondary school tuition or qualified higher education costs are subject to state and federal income taxes, plus an additional 10% federal tax penalty on earnings, 529 payroll deduction pre-tax.

Earnings in 529 plans grow tax-free over time, which is a major perk. When money is invested for a long period of time, it has the chance to grow and accrue tax benefits. Withdrawing funds from a 529 plan account too soon after making a contribution could result in the loss of some of the plan's tax advantages, 529 payroll deduction pre-tax.

One advantage of a 529 plan over other types of savings vehicles is that it is tax-advantaged

Investment in a 529 plan has several advantages over investing in taxable brokerage or even high-yield savings accounts. For one thing, you can take advantage of a number of tax breaks that will reduce your taxable income and help you pay for your education, 529 payroll deduction pre-tax.

Andrew Wang, financial advisor and managing partner at Runnymede Capital Management, says that despite the contribution limits, a 529 plan can still help parents save a significant amount of money, 529 payroll deduction pre-tax.

You can compare a 529 plan to a Roth IRA, but use the money for college expenses instead of retirement, he says. Taxes on earnings and withdrawals made to pay for qualified education expenses, such as tuition and books, are completely tax-free.

It's possible for parents and guardians to earn more than they would by simply putting money away in a savings account. Even though growth isn't assured, the average rate of return on many 529 plans is higher than what you'd find with a deposit account.

Alternatively, you can consider opening a brokerage account, which, depending on your investment strategy, may provide similar growth rates, 529 payroll deduction pre-tax. When compared to 529 plans, where an individual can contribute up to $15,000 (or $30,000 for married couples) annually before the gift tax exclusion phases out, Wang says that parents may like the fact that these types of accounts do not necessarily have contribution limits, 529 payroll deduction pre-tax.

Accredited financial counsellor and host of Her Dinero Matters Jennifer Hemphill says that deciding to use a 529 savings plan rather than other options requires a firm grasp on the long-term goals of one's financial situation, 529 payroll deduction pre-tax.

In order to minimise the burden of student debt, she explains that someone would usually choose a 529 because one of their priorities is having money for their kid's college. It's a great choice for middle-class families who value higher education and can afford to put some of their resources toward it, 529 payroll deduction pre-tax.

Make sure you and your loved ones have prioritised your financial goals before looking into 529 plans. All things considered, a 529 makes sense if you want to help send your child off to college with as little debt as possible, 529 payroll deduction pre-tax.

When deciding on a 529 college savings plan, there are many options to consider

Another type of 529 plan is the prepaid tuition plan. This differs from the 529 plan in that it allows account holders to buy credits or units at participating educational institutions that can be used to pay for a child's future tuition and fees, 529 payroll deduction pre-tax. While many institutions offer the option to prepay tuition, this does not typically extend to other expenses, such as room and board, which are covered by a 529 plan.

A prepaid tuition plan's main perk is the opportunity to save money on tuition costs in the future by locking in today's tuition rates, 529 payroll deduction pre-tax. It's possible to lose some or all of your money if your child doesn't go to a particular school (typically public and in-state participating colleges). Even if you are able to move your funds to another financial institution that is a part of the network, there is no guarantee that the value of your money will increase.

Prepaid plans are declining in popularity, according to Wang, because the plan's beneficiary is limited to a small pool of approved financial institutions. The benefits are generally outweighed by the drawbacks for the average person, 529 payroll deduction pre-tax.

Hemphill concurs, and adds that weighing all of the benefits and drawbacks of a prepaid plan is crucial.

She explains that while prepaid plans can help you lock in today's tuition rates, they won't cover everything. It's important to compare the two plans side by side and figure out which one will work best for your family, 529 payroll deduction pre-tax.

What are the Methods for Evaluating 529 Plans?

Hemphill and Wang, in advising parents on how to choose a 529 plan, stress the importance of researching any potential tax breaks available in their home state. Contributions to a state's 529 plan may be eligible for state income tax deductions in some jurisdictions, such as Colorado; however, some states offer incentives in the form of tax credits for contributions to any 529 plan, 529 payroll deduction pre-tax.

If you're considering enrolling in a state-sponsored retirement plan, it's important to weigh the benefits (such as lower taxes) against the costs (such as lower returns on your investments) before making a final decision. Wang explains, Since fees can differ from state to state, it's important to see whether they'll be higher or lower if you invest in-state, turn on auto-contributions, or opt for electronic statements, 529 payroll deduction pre-tax.

Fees such as enrollment or application charges, management fees, annual account fees, and fund management fees can quickly eat away at your savings. Hemphill chimes in to say that you should also consider learning about your 529 plan's opening options, 529 payroll deduction pre-tax.

They may be higher if you open your 529 through a broker, she warns. In contrast, most 529 plans don't necessitate the use of a broker; you can save yourself hundreds, if not thousands of dollars, by opening the account on your own, 529 payroll deduction pre-tax.

There are other factors to think about besides the size of the plan's minimum investment, such as the diversity of its investment options and the usability of its website. Locating a plan that facilitates contributions from family and friends is also essential, 529 payroll deduction pre-tax.

The child's eligibility for federal aid may also be affected by the identity of the account holder. Income from a 529 plan owned by a grandparent is taxed at the student's rate but distributions from a 529 plan owned by a parent are not, 529 payroll deduction pre-tax.

This distinction means that 529 plans owned by grandparents may reduce a student's eligibility for federal aid. However, Hemphill says the impact is typically small and is conditional on the identity of the plan's owner(s), the amount of the withdrawal(s), and the type of assistance sought.

Wang recommends switching 529 plans if you end up not liking the one you initially select. The Internal Revenue Service permits a person to make one taxable rollover to a different qualified retirement plan each year, 529 payroll deduction pre-tax.

Does contributing to a 529 plan affect federal student aid eligibility requirements?

A student's ability to qualify for need-based financial aid for higher education may be affected by contributions made to a 529 plan, though this may not always be the case depending on the specific institution, 529 payroll deduction pre-tax.

Financial aid for elementary or secondary school tuition might be affected if you have money saved in a 529 account for future qualified higher education expenses. Loans may make up the bulk of a family's financial aid package. Therefore, the more money you or your student can put away for school, the less debt they are likely to take on.

Finances and tax breaks

Named after the 1996 addition of Section 529 to the Internal Revenue Code, which encouraged families to save for higher education, 529 Plans are popular because of the tax and financial aid benefits they offer, 529 payroll deduction pre-tax.

Money put into a 529 plan is done so with after-tax funds. Your earnings in a 529 plan grow tax-free. With a 529 plan, qualified withdrawals are completely free of federal income tax. Contributions to a state's 529 plan qualify for a state income tax deduction or tax credit in 35 states (and the District of Columbia).

If you contribute more than $15,000 per year ($30,000 per year if you and your spouse both give) to a 529 plan, you may be able to take advantage of a tax-saving strategy known as 5-year gift tax averaging, which treats your gifts as though they were spread out evenly over five years. A single contributor can put away up to $75,000 ($150,000 for a couple) in a single year into a 529 plan without having to pay gift taxes.

When determining eligibility for federal student aid, 529 plans are treated as parent assets and distributions are disregarded if the plan owner is either the student or the student's parent. In comparison to the treatment of student assets, this results in a more generous financial aid package, 529 payroll deduction pre-tax.

Student assets reduce eligibility for need-based aid by 20 percent of the asset value, compared with at most 5.64 percent of the asset value for parent assets. Beneficiary eligibility for need-based aid may be reduced by as much as half the amount distributed from a 529 plan owned by someone other than the beneficiary because distributions are treated as untaxed income to the beneficiary.

How might your 529 plan affect your eligibility for student aid? Make an informed decision about your financial aid options by calculating your expected family contribution (EFC) and your financial need with our Financial Aid Calculator, 529 payroll deduction pre-tax.

Other benefits of 529 plans

529 plans provide a number of important advantages, including tax and financial aid savings.
Investing in a 529 plan is something you can do whenever you like. A person may establish as many Section 529 plans as they see fit.
The account's owner, not the minor, has administrative rights. In other words, the minor does not become legally responsible for the account once they turn 18. If the child does not go to college, the account holder can designate a new beneficiary.
Everyone is welcome to put money into a 529 plan. There are no income phase-outs on contributions to a 529 plan. Individuals of any age can make contributions. There are substantial aggregate contribution limits for 529 plans; the amounts vary from $235,000 to $520,000.
Money saved in a 529 plan can be used for any purpose at any time. Withdrawals from a 529 plan are not affected by the recipient's income level. A 529 plan is not limited to paying for an undergraduate education; it can also be used to fund professional degrees like those in medicine and law.
Depending on the jurisdiction, newborn children in some states and some cities are eligible to receive a small contribution to their 529 plan account if the account is opened prior to the child's first birthday.

Having this starting fund available has been shown to improve a child's chances of enrolling in and completing college. Low-income families in some states can get their 529 plan contributions matched by the state.

Which 529 plan is best?

Many options exist for saving for college because 529 plans are not limited to residents of any one state. If you live in one of the 35 states (plus DC) that offer state income tax deductions or tax credits for contributions to the state's 529 plan, you may want to look into the plan available in your home state, 529 payroll deduction pre-tax.

Investigate 529 plans with the lowest fees. If you want a high ROI, cutting costs is the first thing to do. To make an informed decision, evaluate 529 plans by their net returns after deducting annual fees, 529 payroll deduction pre-tax.

A 529 plan can be opened either independently or with the help of a financial planner. Advisor-sold plans typically have higher fees, but a financial expert can help you choose a plan and determine which investments are best for your college savings needs, 529 payroll deduction pre-tax.

What factors should be considered when choosing a 529 plan investment?

You can tailor a 529 plan to meet your specific financial goals by choosing from a variety of investment options. There are typically dozens of investment options available within a 529 plan. U.S.

Stock funds, international stock funds, real estate funds, bond funds, money market accounts, and cold hard cash are all available as static funds among the investment options. Some financial institutions also provide certificates of deposit. You can combine these funds to create an investment strategy that suits your risk appetite exactly.

Flexible investment options, such as asset allocations based on a beneficiary's age, are typically available in 529 plans. As the college years draw near, the proportion of riskier investments in the portfolio is reduced in accordance with an age-based asset allocation. These funds are similar to target date funds found in retirement accounts, 529 payroll deduction pre-tax.

The best way to put money into a 529 plan

Minimum contributions to 529 plans can range from $10 to $15 or even be waived entirely in some cases. In most cases, you can make your initial contribution by mail or online banking, and ongoing payments can be made through payroll deduction or automatic deposits. Automatic investment plans linked to checking or savings accounts may have lower contribution minimums than non-automated plans, 529 payroll deduction pre-tax.

Monthly contributions to a 529 plan are an easy way to stay on track with your savings, but are not required. Some parents prefer to make a large initial deposit and then supplement their contributions with cash gifts received at Christmas and birthdays. It’s up to you to contribute as much as you want, whenever you want.

Contributions to a child's 529 plan are not limited to parents and grandparents. There are a variety of options for soliciting online donations these days, including pre-made email and social media posts as well as websites where donors can create their own personalised donation pages. Money can be deposited into the account holder's bank account or mailed as a check, or a Gift of College gift card can be purchased, 529 payroll deduction pre-tax.

Every other outlay of funds is not tax deductible

Earnings included in a nonqualified distribution are taxable as ordinary income at the beneficiary's rate and subject to an additional 10% tax penalty. To the extent that a beneficiary receives tax-free educational assistance (such as a scholarship, educational assistance from the Department of Veterans Affairs, employer-paid tuition assistance, or other tax-free forms of educational assistance), attends a U.S. military academy, or claims the American Opportunity Tax Credit or the Lifetime Learning Tax Credit, the tax penalty will be waived.

If the person you've named as beneficiary changes their mind about attending college, you can always designate someone else, use the money yourself, or put it away for a future grandchild. You may also make a withdrawal that is not considered a qualified distribution at any time. The distribution is taxed and subject to penalty only on the earnings portion. Contributions (the principal) made with after-tax dollars will never be subject to taxation or penalty, 529 payroll deduction pre-tax.

Methods for Determining Qualified Expenses for a 529 Plan

Withdrawals from a 529 plan are tax free up to the amount of qualified higher education expenses paid during the year, less any amount used to generate other federal tax benefits, 529 payroll deduction pre-tax.

The American Opportunity Tax Credit (AOTC) and the Lifetime Learning Tax Credit may provide additional tax benefits to parents who use 529 plans to fund higher education expenses (LLTC). Federal tax credits for higher education are available to families, but only if they earn enough.

If you spend $4,000 on approved education costs, you can receive a $2,500 credit from the AOTC (a 100% refund on the first $2,000 spent and a 25% refund on the next $2,000 spent).

Withdrawals from a 529 plan are tax-free only if used for qualified education expenses that were not covered by the payments that generated the additional education tax credit (AOTC). To calculate the appropriate withdrawal from the 529 plan in this case, the taxpayer would deduct $4,000. from the amount they actually spent on qualified educational expenses, 529 payroll deduction pre-tax.

Some families may not be eligible for the credit at all, while others may receive a smaller credit due to the credit's phasing out at higher incomes. You may want to consult a tax professional or accountant for more tailored advice.

Withdrawing funds from your 529 plan in the same calendar year that you paid for the qualified expense is required. You can't use money from your 529 plan for an expense one year and then pay for it the next, 529 payroll deduction pre-tax.

So What Happens if the Account Beneficiary Doesn't Go to College?

One can do a few things with a 529 plan for someone who ends up not going to college. Taking the cash outright and spending it on things other than school is one option. Still, there will be consequences (more on those later).

You also have the choice of modifying the account's beneficiary. If a parent has two children, for instance, one of them could be named as the beneficiary of the account and the rest of the money could be used for the benefit of the other child, 529 payroll deduction pre-tax.

If the new beneficiary is a spouse, parent, child, or grandchild of the account holder, there will be no tax consequences for changing the beneficiary.

Most 529 plans have a beneficiary change form available on their websites, so you can make the change whenever it's convenient for you. If you don't want to invest in your future education by going to graduate school, you could use the money to pay off your student loans, 529 payroll deduction pre-tax.

What Happens to a 529 Plan If It Is Used for Non-Eligible Costs?

Withdrawing money from a 529 plan is possible at any time and for any reason, but if the funds are used for anything other than qualified education expenses, the earnings portion of the withdrawal will be subject to income taxes. Additional 10% penalty on those earnings is due as well.

Additional penalties may be imposed by individual states

The federal tax penalty is 10%, but California adds another 2.5%. Contributions to a 529 plan may be deducted from your state income tax, but states that do so may also require you to pay the taxes you would have otherwise owed, 529 payroll deduction pre-tax.

The rules regarding penalties, however, are not always strictly adhered to. When you attend a military academy, receive a qualifying scholarship, or qualify for educational tax credits, you may be able to withdraw funds from your 529 plan to use for non-qualified expenses.

In modern parlance, prepaid 529 plans are a relic of the past. A prepaid tuition plan allows you to buy tuition units or years in advance, guaranteeing that you will pay the current rate for your education. Yearly tuition will always be equivalent to the value of one academic year, 529 payroll deduction pre-tax.

Investment returns typically fall short of annual increases in college costs, so students typically pay a premium on top of the going rate of tuition. There are not enough funds in many prepaid tuition plans to pay for all expected tuition costs in the future.

A state's full faith and credit may not underpin the guarantees offered by all prepaid tuition plans. Whether or not the state guarantees the prepaid tuition plan is unclear. There are no longer any opportunities to invest in prepaid tuition plans, and many of those that remain cannot cover the full cost of education. If the funds aren't available, your child may have to wait until he or she graduates high school to spend them.

One-third of those who participated in our College Savings Survey were under the impression that 529 savings were ignored by universities when determining need-based aid, 529 payroll deduction pre-tax.

However, this is not always the case and depends on factors such as the plan's ownership, the timing of withdrawals, and the type of financial aid being sought. Most 529 plans will have a positive impact on your financial aid package rather than a negative one. Also, there are things you can do to improve your child's financial aid profile.

Types of aid

It is a requirement of all colleges that participate in the Federal Student Aid Program that students submit the Free Application for Federal Student Aid (FAFSA). The FAFSA is used by universities to determine a student's EFC, or expected family contribution (EFC).

However, the CSS Profile is used by fewer than 200 institutions to determine which students are eligible for institutional grants. Each form has its own method of calculating a family's wealth. For instance, a grandparent's 529 plan assets would not be reported on the FAFSA, but the CSS Profile may require students to disclose them, 529 payroll deduction pre-tax.

Given the small number of institutions that use the CSS Profile and the wide range in institutional requirements, we will instead discuss the impact of a 529 plan on the Federal Student Aid Application (FAFSA).

Account Ownership

The value of a 529 plan held by a parent or a dependent student (529 plans do not permit joint ownership) is counted as a parent asset when determining eligibility for federal student aid. The Asset Protection Allowance covers approximately the first $10,000 (the exact amount will vary depending on the age of the older parent). A parent's assets above the allowed amount may reduce a student's financial aid by up to 5.64 percent of the value of those assets.

A parent's financial aid award may be reduced by as much as $564 if his or her 529 plan balance is more than the Asset Protection Allowance by $10,000. While a loss of $564 is never welcome, the gains you've made on investments tax-free in your 529 plan may more than make up for it, 529 payroll deduction pre-tax.

However, the treatment of other student-owned property is less favourable. The value of a student's assets, including a UGMA/UTMA custodial account, will be subtracted from their financial aid award by 20%.

To put it another way, if a student has $10,000 in assets, they will receive $2,000 less in aid. As was previously mentioned, the FAFSA does not take into account the value of a grandparent's or other relative's 529 plan, 529 payroll deduction pre-tax.

Earnings

The FAFSA will consider a student's interest, dividends, and capital gains if they appear on the student's federal income tax return. If this income is included in the calculation of EFC, it will be counted as half of the total, 529 payroll deduction pre-tax.

However, earnings in a 529 plan are not considered when determining eligibility for financial aid and do not need to be reported on the FAFSA, 529 payroll deduction pre-tax.

The effect of distributions from a 529 plan on federal financial aid will also vary depending on the account holder. Withdrawals from a 529 plan owned by a parent or student will not affect financial aid eligibility. What this means is that if you cash out your savings to pay for your child's sophomore year of college, it won't have any bearing on the next year's FAFSA.

When a grandparent or other relative is the account holder, however, things become more complicated. While the money is in the grandparent's 529 plan, the student won't have to report it on the FAFSA, but withdrawing it to pay for college will be considered untaxed income. When determining eligibility for need-based financial aid, untaxed income is treated the same as taxed income.

Let's pretend a grandma wants to pay all $45,000 of her grandson's private university tuition for one year. He'll be a first-year student this coming fall, and he plans to apply for aid every year. It's possible that his federal aid package could be reduced by as much as $22,500 because of the untaxed student income he earned from Grandma's gift in his third year of college (when he is required to report prior-prior year income).

To avoid this, Grandma can wait to pay her grandson's college tuition until after his final FAFSA has been processed, on January 1 of his sophomore year. Of course, this is predicated on the idea that he will complete his degree in that time frame, 529 payroll deduction pre-tax.

The student's aid package for the following year could be reduced by up to $2,538 ($45,000 x 5.64 percent) if the account were transferred to the parent.

There is a third choice, which is to transfer one year's worth of funds at a time from the grandparent's 529 to the parent's 529. To avoid having the grandparent 529 account count as an asset on the FAFSA, the transfer should be delayed until after the application has been submitted, 529 payroll deduction pre-tax.

You should just make sure to spend the money before filing the next FAFSA. Some 529 plans have recapture rules when you roll over the funds to a different state's 529 plan, so make sure to open the parent 529 account in the same state as the grandparent 529.

If you don't end up withdrawing from your 529 plan, what should you do with the money?

If your child does not go to college or if you do not use all of your 529 savings to pay for their education, you have several options.

First, you can use any remaining funds in the 529 plan for your own qualified educational expenses or transfer them to another eligible child or dependent. In order to do this, contact your 529 plan provider and ask for instructions on how to update the account's beneficiary, 529 payroll deduction pre-tax.

In any other case, you can get the money, but you'll have to pay a 10% penalty on top of whatever income taxes you owe. To avoid tax consequences, you can transfer the funds to the ABLE account of a family member. People who were disabled and started receiving Social Security insurance benefits before the age of 26 are eligible for these tax-deferred accounts.

To manage your costs and expenses you can use many available online accounting software.

Key Takeaways

All or part of your prepaid tuition may be lost if the plan's sponsor experiences financial difficulties. Another caveat is that the prepaid tuition plan might pay out less if the beneficiary doesn't go to a school that participates. The return on investment might be negligible.

Parents who are considering contributing to a 529 plan for their child's future higher education expenses may be concerned that doing so will jeopardise their child's chance of receiving federal financial aid. If this describes you, know that you are not alone. One-third of those who participated in our College Savings Survey were under the impression that 529 savings were ignored by universities when determining need-based aid.