Family Finance: The Plusses of 529 Plans

Julanne Hohbach

Saving for college: It's a concept that can strike fear into the hearts of most parents. First, of course, there's the denial that your child will ever be old enough to matriculate. But once you accept that eventuality, visions of dollar signs, loans and debt take over.

Setting aside money that won't be used for up to 18 years can be tough, especially in the early days, when a year's worth of child care bills can cost as much as a year of tuition. Some parents, in fact, avoid putting any money aside for college until day care bills drop, reasoning they'll just divert the cash from one expense to the other.

Other parents assume their son or daughter will pay for college with student loans. That seems reasonable, until you do the math. For 2017-18, the average national cost for college tuition plus fees at four-year schools was $9,970 for in-state students and rose to $25,620 for out-of-state students, according to theCollege Board. (Ohio's averages are $10,510 and $25,000, respectively.)

However, the U.S. Department of Educationcaps the maximum total amount that undergraduate students may borrow at $31,000 for those whose parents still claim them as dependents. That breaks down to just $7,750 per year of a four-year degree.

For many families, 529 plans are a good way to fill that funding gap (though the plans also are available to students whose parents make too much money to qualify for direct subsidized loans). Officially known as qualified tuition plans, 529s are named for the section of the tax code under which they are authorized. Every state offers at least one, as does the District of Columbia.

Anyone 18 or older can open an account—parents, grandparents, friends or even a student. Note that the person who opens the account, not the designated beneficiary, maintains control of the funds. Each account has a sole beneficiary, so if you have multiple children, you'll need an account for each. If one child later decides college isn't for him, you can change the beneficiary to another family member.

Investors who open a 529 account have two funding options: a prepaid tuition plan or a savings plan. With a prepaid plan, account holders buy “credits” toward tuition at participating institutions. The savings option, on the other hand, acts as an investment account that funds educational expenses. These come with a range of investment choices, from no-risk certificates of deposit to more volatile stock funds. Before you open an account, make sure you understand the fees, which will lower your investment returns.

The U.S. Securities and Exchange Commission, which offers an onlineintroduction to 529 plans, cautions that prepaid plans generally cannot be used for room and board and—perhaps more significantly—the funds aren't guaranteed by the federal government. Because these plans typically are state-sponsored, they usually lock the student into attending a public, in-state institution. (Ohio does not currently offer a prepaid plan.)

Using 529 plans as savings vehicles offers significant tax advantages: Earnings are tax-free, and money withdrawn from the account to pay qualified educational expenses also is not taxed. (If it's used for another purpose, however, taxes and penalties may apply.)

Ohioans can open a 529 account through the state'sCollegeAdvantage plan, administered by the Ohio Tuition Trust Authority, or shop elsewhere. CollegeAdvantage consistently receives high marks from, and was ranked among “best-in-class” offerings last year byMorningstar. Funds can be used at institutions nationwide, including technical schools.

In addition to past financial performance, the state plan has another advantage: Residents of the Buckeye State can deduct up to $4,000 in account contributions per year, per child, from their state taxable income.

CollegeAdvantage accounts can be opened for as little as $25, with contributions by check, bank transfer or set up as automatic recurring deposits. There's even an option for relatives to give gifts.

It's worth noting that money in a 529 plan may slightly lower a student's need-based financial aid offer, though not by much. A student can expect to lose 5.6 cents in aid for every dollar in the account. But it's a better option than socking away money in the bank, which Bankrate says can bring a loss of 20 cents on the dollar. Through the magic ofcompounded interest, however, you can probably make that nickel back—and then some—if you invest early and play your cards right.