How to Invest in Your Child’s 529 College Fund

February 9, 2022

Why is college so expensive? The average American student can rack up an overall cost of more than $400,000 for a bachelor’s degree. Another damning statistic is that 65% of students graduate with student debt.

Such statistics are enough to scare away many parents from putting their child in college. However, there is a smart solution to secure your child’s education and career path—a 529 plan. No doubt building the plan is challenging, but it’s the best place to put your money for debt-free college life.

What Are 529 College Funds?

A 529 plan is simply a tax-advantaged and state-run savings plan that enables you to save for your child’s future education expenses. This is a way for a parent to optimize their savings to cover qualified college costs such as tuition, fees, and books.

You can open a 529 plan regardless of your income or age, which is a great advantage as you can start saving for college earlier. In addition, depending on the state and the 529 plan, you can also pay for a K12 program. As of January 1st, 2018, the law allows you to pay up to $10,000 for tuition payments for public, private, and religious education from kindergarten to high school.

The college funds can be held either in a prepaid tuition plan or an education savings plan.

  • Prepaid tuition plan: This plan allows you to pay for future college fees by buying credits based on today’s in-state tuition costs. It’s a solid plan given that college fee rates keep rising, and it’s also a state-backed plan. The catch is that most of the plans only allow for participants who are residents in the state providing the plan. In addition, when your child is ready to start school, you can only allocate the funds towards college tuition or fees or risk a 10% penalty for nonqualified expenses.
  • Education savings plan: This is a popular plan among parents as you have more leeway in choosing the best 529 plan investment options from any state you prefer. Your child will also be able to utilize the savings as there’s no age limit. You’re also not taxed when you withdraw funds to cover qualified higher education expenses at any college or university you choose. However, since you have a choice of investments, you may have to work with a professional to be safe from volatility and investment loss.

Before choosing either plan, it’s good to weigh the benefits and drawbacks of both.

What States Offer 529 Plans With Tax Incentives?

You’re free to open a 529 plan in any of the 50 states, including the District of Columbia. The plan is also available in some private colleges and universities. Every state has its own rules on how they administer 529 plans, so it pays to find out which states could offer you the best tax savings.

At the very least, with a 529 college fund, your child’s college savings will grow tax-deferred, and over 30 states offer a tax deduction or credit with a unique set of restrictions. However, not all states have tax breaks.

States That Have Income Tax Deductions in Any 529 Plan

Seven states allow you income tax deductions for contributions to any 529 plan, including other states. They are:

  • Arizona
  • Arkansas
  • Kansas
  • Minnesota
  • Missouri
  • Montana
  • Pennsylvania

The upside to living in any of these states is the flexibility to choose the best investments to optimize returns and the most affordable plan. From this list, Pennsylvania offers the highest deduction of up to $15,000 for every individual per year, including protection for your 529 plan savings against state-based creditors and state inheritance taxes.

States With Income Tax Deduction for In-State Plans

Residing in these states means you can claim the deduction for 529 plans within just those states. If you’re looking for the biggest deductions, South Carolina, New Mexico, Colorado, and West Virginia offer fully deductible plans. As for the rest, each state has different deductible limits from as low as $500 up to $10,000 per beneficiary per year. These include:

  • Alabama
  • Connecticut
  • Washington, D.C.
  • Georgia
  • Idaho
  • Illinois
  • Iowa
  • Louisiana
  • Maryland
  • Massachusetts
  • Michigan
  • Mississippi
  • Nebraska
  • New York
  • North Dakota
  • Ohio
  • Oklahoma
  • Rhode Island
  • Virginia
  • Wisconsin

States With a Tax Credit for 529 Plans

Aside from deductions for most 529 plans, here are four states that have a tax credit.

  • Indiana: A contributor is entitled to a 20% tax credit for contributions of up to $5,000.
  • Minnesota: The contributor can choose between a 50% credit on contributions up to $500 or a $1,500 deduction for single filers and $3,000 for joint.
  • Utah: A contributor can claim a 5% tax credit per individual for contributions up to $2,040 for single filers or $4,080 for those filing jointly.
  • Vermont: Any contributor is allowed a 10% tax credit per person every year for contributions of up to $2,500 or $5,000 for single filers and joint filers, respectively.

What Is an Age-Based Portfolio and Why Might a Family Pursue This Option?

One of the selling points of being the account owner of a 529 plan is the freedom to control your investments. Factoring in your family’s needs, return objective, and risk profile, it’s prudent to choose an investment strategy that will offer full coverage when your child enrolls for higher education.

When settling on a strategy to build and maintain your 529 plan portfolio, you can opt for tailor-made investment choices (static) or a “set it and forget it” approach (age-based).

A static portfolio works best for seasoned investors as they select which portfolios to reallocate the assets. Typically, the asset allocation remains constant over time until the investor takes action. Such a plan aims for a specific risk level that involves aggressive growth or income. It also extends to individual portfolios, which feature underlying mutual funds or exchange-traded funds.

However, most investors go for age-based portfolios as they’re professionally managed to eliminate the stress of balancing their investment allocations. Typically, an age-based option adjusts per the age of the beneficiary. In the beginning, it targets risky asset allocation such as stocks to generate the most return, but as college time nears, it shifts to low-risk assets such as money market funds or bonds.

Families that have understood their risk tolerance and want to avoid making poor investment choices usually choose age-based portfolios. The one downside is age-based 529 plans just cover college fees.

Financial Takeaway

While families differ in terms of their individual investing needs, there are universal methods to save for college using a 529 college fund. An age-based portfolio resonates with most parents because it’s hands-free and prioritizes capital preservation as your child nears college enrollment.

If you’re thinking of starting a 529 college fund, now is a better time as most states provide some form of tax deduction or credit, allowing you to build a substantial college fund for your child.

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