Step-by-step guide to opening a 529
Parents shouldn’t be intimidated by opening a 529 plan. In fact, the process is relatively simple.
“The biggest hurdle for parents is there’s the fear of getting in there and you need someone to push you to do it,” says Megan Gorman, a personal finance expert and founding partner of Chequers Financial Management. “But the system is set up so well and there are so many cost-effective plans that do all the work — parents just need to open the account and put some money to work.”
Opening a 529 can be completed in (as little as) these four steps:
1. Select a plan
You’ll have to choose between a savings plan or a prepaid plan. According to Gorman, parents can open a plan with any provider, regardless of state — but she recommends prioritizing the quality and cost of the plan you choose to invest in first, and then consider any state tax benefits the plan may provide.
“This is important as you don’t want to invest in an expensive plan that underperforms just because of the tax benefit,” Gorman says.
Every state and the District of Columbia offers a 529 plan. It is even possible to open multiple 529 plans in multiple states.
However, each state’s 529 plan has its own set of advantages, and they are limited to residents in some cases. For example, there may be a state income tax credit only available to residents of the state offering the plan.
There are other considerations, too, such as enrollment fees and minimum contribution amounts. If you want to know how to open a 529 plan, the College Savings Plan Network (CSPN) has a comparison of 529 plans across different states. It also has a map that lets you easily find your state’s plan.
If you aren’t sure which provider or plan works best for you, consider contacting a financial adviser for advice. A 529 plan broker may also be able to give you assistance.
2. Choose a beneficiary
This will likely be your child — but remember, you can change the beneficiary at any time without penalty. You will need the beneficiary’s date of birth and Social Security number. Since most plans have age-based options, meaning they have a target-allocated fund that reallocates based on a child’s age, it’s best to open an individual account for each child.
In general, anyone can be the beneficiary of a 529 plan; it is not limited to children or any other type of relationship. The beneficiary must be a U.S. citizen or resident alien and have a social security number or tax identification number. As long as those requirements are met, there are no restrictions on whose name can be on the plan. In fact, even the person opening the 529 plan can be its beneficiary.
3. Open the account
Most accounts can be opened online. Once opened, you can deposit funds directly into the account (some plans require a minimum deposit for opening.) Be sure to keep an eye out for any fees associated with providers and plans; there can be annual fees, account opening fees and percentage fees. Always read the fine print.
The information you will need to open a 529 account may vary by plan. In general though, expect to be asked for details such as social security number (or tax ID), date of birth, and address. You must provide that information for both yourself (or the person opening the plan) as well as the beneficiary.
A 529 plan works much like other types of investment accounts. Thus, you can employ age-based investment strategies, conservative, moderate, or aggressive investment mixes, or a mix or your own funds. And since these accounts are like other investment accounts in many ways, automatic investments are also an option.
4. Build your portfolio
If you’ve chosen a savings plan, you can choose where to invest your money. Most providers offer both actively and passively managed investments, says Gorman — but she recommends using aged-based funds.
“These funds are similar to target retirement funds,” Gorman says. “They automatically adjust the asset allocation based on the child’s age.”
That means the funds become more conservative as the date for tapping the funds nears, helping to ensure that you have the money when you need it.
If you need help, some plans have advisory fees — but be sure to review these beforehand.
“It’s really easy — you don’t need to be sophisticated or need someone who is sophisticated to open it for you,” says Leslie H. Tayne, Esq., founder and director of the Tayne Law Group in New York. “Don’t be discouraged because it sounds complicated, because it’s not.”
Important 529 plan rules to know
Since 529 college savings plans provide tax incentives, the IRS writes strict rules to ensure they aren’t being taken advantage of. While contributing to a 529, keep these important rules and restrictions in mind:
Anyone can be named a beneficiary, including yourself, and there is no limit to how many plans you can set up.
Contributions cannot be more than the amount needed to provide for qualified expenses of the beneficiary, according to the Securities and Exchange Commission (SEC). The SEC also cautions to “be aware that there may be gift tax consequences if your contributions, plus any other gifts, to a particular beneficiary exceed $15,000 during the year.”
Gorman does point out, though, that most Americans won’t come close to reaching the maximum contribution.
“Parents get very apprehensive that they’re going to overfund a plan — but most people don’t even really get close,” Gorman says. “So overfunding really should not be of concern.”
Balances in 529s could affect financial aid rewards. Balance amounts are taken into the expected family contribution (EFC) amounts, but Gorman points out the calculation used will vary, depending on who owns the account. For example, if a parent owns the account, the amount considered in the family contribution is around 5 percent; if someone else were to own the account, like grandparents, distributions could reduce eligibility for need-based aid by as much as 50 percent. If the student owns the account, eligibility could be reduced by as much as 20 percent of the asset value.
“It does seem a bit draconian, especially in the day and age where college costs are so high and it really, truly takes a village.” Gorman says. “It’s a bit unfair, but they’re trying to make sure people don’t start gaming the system.”
Gorman adds, however, that considering financial aid implications should “never be a deterrent” when choosing to open a 529 plan.
What happens if your child doesn’t go to college
Since a 529 savings account is specifically for educational costs and provides tax benefits, there will be penalties if the money is not used for its intended purpose. According to the IRS, withdrawn funds used for anything other than tuition and qualified expenses will be subject to income tax and face a penalty on the earnings.
There are, however, instances when these penalties may be waived, including:
- The beneficiary receives a tax-free scholarship.
- The beneficiary attends a military academy.
- The beneficiary dies or becomes disabled.
If your child chooses to sidestep higher education altogether, you won’t lose the money in the accounts. Instead, you have the option to change the beneficiary — which you can change to yourself for future education or for grandchildren. Anyone can be named a beneficiary, and there aren’t any rules capping how many times a 529 plan beneficiary can be changed.
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