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With rising tuition rates, saving for your child’s college education can seem overwhelming. In-state tuition at a public four-year institution now runs a student $10,940 a year, according to a report by the College Board. This amount is more than double what it was 30 years ago ($4,870).
While there are many options for financial aid available through scholarships and grants, families can give their college students a cushion by saving early and often for school. One option is a 529 plan, also known as a qualified tuition plan. This tax-advantaged savings plan is designed to help you pay for education.
How To Open a 529 Account
1. Select a 529 Plan
Before you can open a plan, you’ll need to decide which one is right for you. You can choose from two types of plans: prepaid tuition or a savings plan.
- Prepaid tuition. This plan allows you to make payments on a plan that locks in today’s tuition costs. You’re making advance payments on tuition for your child, so when they go to college, they aren’t paying based on the current year’s costs. Think of it like paying for your child’s college ahead of time and at a discount. In most cases, it covers tuition and fees but not books, supplies and other expenses.
- Savings plan. This 529 option lets you save money for college-related expenses, including transportation and child care costs. Contributions are tax-deductible in some states and the money grows tax-free. Withdrawals aren’t taxed unless the funds are used for non-school costs.
The plan you choose doesn’t just determine how your account is structured but how you will use the funds. Some parents might want the potentially lower tuition rate, while others don’t want to lock their child into a specific school through a prepaid tuition plan. Everyone’s circumstances are different.
2. Name a Beneficiary
Once you select the plan type and open your 529 account, you can name a beneficiary. The beneficiary is the person who will receive the money. Whether you’re opening the account for a child who’s just a few months old or one who’s currently in high school, you need to name a beneficiary.
One child can be listed as the beneficiary in several 529 plans, and you can change the beneficiary on your plan at any time without penalty. Suppose you opened an account for one child who doesn’t plan on going to college. In that case, you can change the beneficiary to another child, yourself, another relative or someone else. There isn’t a limit to how many plans you can have open.
3. Open an Account Online
Remember that you aren’t restricted to buying a plan only in your home state. Some plans are offered to anyone, whether you live in the state or not. But read the requirements carefully, since some state plans have residency or attending requirements. This means you might need to attend a school in the state where the plan was purchased.
As you’re looking through plans, pay attention to:
- State residency requirements. Do you have to live in the state to take advantage of the plan?
- Fees. There are asset-fee ratios, account maintenance fees and more.
- Maximum contributions. How much does the plan allow you to contribute? Some plans max out at $500,000.
- Tax deductions. Does your state offer tax deductions on contributions? This might be a bonus.
4. Select Your Investments/Portfolio
If you choose a 529 savings plan, you’ll get to build your investment portfolio. Savings plans take your contributions and invest them similar to retirement plans, like an IRA or 401(k). You can take charge and actively manage the account or give the reins over to someone more experienced with a passively managed account.
Investments can change as your child ages. You might want to consider an age-based plan. For example, if you open an account when your child is young, you might invest in more stocks. The older they get, the less risky your account might be, especially as you start making withdrawals.
5. Fund the Account
Like any other account, you’ll need to set up regular contributions so the money continues to grow. Many accounts let you make an initial deposit so your money gets invested right away (if you pick the savings plan). For most accounts, you can set up recurring transfers from your bank account to your 529 plan, similar to auto bill pay.
How To Use Money From a 529 Plan
How you use your 529 plan money depends on the plan type you choose. If you select the prepaid tuition plan, your money is usually reserved only for tuition and fees. In most cases, you can’t pay for room and board with those dollars.
Many prepaid plans have state restrictions, meaning you might either have to live in the state or plan to attend school in the state to qualify. Not all savings plans have this restriction.
Savings plans let you use the funds on nearly anything related to college costs, including:
- Tuition and fees
- Room and board (on or off-campus)
- Child care
- Books, supplies and equipment
- Some bills (like internet)
- Some food and living expenses (for off-campus residents)
If you use the funds for non-eligible costs, you could pay a 10% federal tax penalty.
Remember, as with any investment account, there is some risk when investing in a 529 plan. While you could earn money based on your investments, you could also lose money. Keep this in mind as you’re selecting your plan and investments.
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