What Is a 529 Plan? Should You Buy It?

The student loan pause is all set to come to an end in October. In the last 30 years, tuition costs at public four-year colleges have increased from $4,160 to $10,740 and from $19,360 to $38,070 at private nonprofit institutions, per Forbes. No wonder students are reeling under loan debts ($1.75 trillion in total, to be precise).

There are several ways to avoid a student loan — one such way is to start saving early for college. A 529 plan can be a perfect way to do so. This is a tax-advantaged plan to save for your child's education. Not every state offers the same 529 plan, so it's important to do your research before investing in a 529 plan.

Here's an overview of the plan originally designed to just help people save for college fees and which now does so much more.

What Is a 529 Plan?

This plan is essentially an education investment account. Each state sets its fees for management and also mutual funds separately, similar to how a 401(k) is negotiated depending on the employer, per Forbes. You are permitted to withdraw up to $10,000 which will be tax-free and can also be used for some K-12 costs depending on the state you live in. 

How to Choose the Best 529 Plan?

Each US state offers its own 529 plan. Jesse Little, senior director of advice for Wells Fargo told Fox Business, "It is prudent to perform due diligence on the differences in plans prior to opening an account."

According to many financial experts, choosing the right 529 plan involves assessing the tax benefits offered by the state which will help you decide whether you want to pursue the plan or opt for a third party.

Who Can Be the Beneficiary in the 529 Plan?

The beneficiary (the funds will go towards the education of this person) can be anyone with a valid Social Security or Taxpayer Identification Number but they must be a US citizen or resident alien. They need not be a family member. You can be a beneficiary of your own plan. However, it's important to note that the person who opens the account will have control over the money and will be the only person who gets to make the investment-related decision for the account. 

What Are The Types of 529 Plans?

There are mainly two types of 529 plans-- prepaid tuition plans and education savings plans.

What are Prepaid Tuition Plans?

In this plan, you can save for your kid's future. This allows you to pay for the tuition fees in advance, all at the current rate. This is possible by purchasing units which are also called credits. When your kid goes to college, you will be able to withdraw the funds. This plan also lets you transfer the credits to some other kid in the family.

What Are the Tax Benefits in Prepaid Tuition Plans?

You will not have to pay tax on any withdrawals as long as you are using them for qualified expenses. This plan also permits the contribution with your post-tax income which helps you get both state and federal tax benefits.

What Are 529 Savings Plans?

This plan permits you to save in various kinds of mutual funds, bond funds and also exchange-traded portfolios. Very similar to 401(k)s and IRA plans, your account rises or falls depending on the market.

When Inflation Is High, Is It a Good Idea to Invest in a 529 Plan?

It is better to save money in a 529 plan than a regular savings account in the current inflation scenario. Savings accounts have been offering an interest rate of 3%, which is higher than usual, so you would want to stick to a 529 if you know for sure that your money needs are mostly for education purposes to combat inflation. However, it's best to consult with a financial advisor before taking any major decision.