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10 Common Myths About 529 College Savings Plans
Questions abound regarding 529 education savings plans. Most come from misunderstandings about what a 529 education savings plan really is and what it can do for you. It is actually very simple: a 529 education savings account helps cover the costs of higher education and allows you to avoid paying federal taxes on earnings and withdrawals from the fund.
Let’s debunk some common myths and learn about the realities of 529 education savings accounts.
Myth: “Free college” programs and scholarship opportunities mean I don’t need to save for college.
Reality: The increasing number of “free college” programs and scholarships, including the New Mexico Opportunity Scholarship, can help students and families cover tuition and fee costs at eligible in-state public institutions. They are a great additional tool for families planning for higher education. But tuition is just one of many costs involved with a college education. Tax-free withdrawals can be made from your 529 account to cover other qualified education expenses, including room and board, textbooks, laboratory fees, special needs assistance, even computers, printers, software and internet access, if required for courses. According to the College Board, the average total annual cost of college for a full‐time, in‐state student at a public four‐year university is over $27,000. Over a third of that is for tuition but those other expenses cost nearly $17,000 per year.
Myth: If my child doesn’t go to college, I will lose the money.
Reality: If your child chooses not to attend college, it does not mean your 529 investment is lost. If your child doesn’t use the 529 Plan savings, you have three options: you can keep the money in the account in case your child changes his or her mind in the future, change the account beneficiary or make a nonqualified withdrawal. Eligible beneficiaries must be family members as defined by the IRS, and that list is quite exhaustive: adopted children, stepchildren, stepparents, nieces, and nephews, aunts and uncles, in-laws, grandparents, first cousins, and even yourself or your spouse. When withdrawals are used for other nonqualified purposes, the earnings portion of the withdrawal is subject to federal income taxes and any applicable state income tax, as well as an additional 10% federal tax and the recapture of any tax deductions taken for contributions to an account.
Myth: Having a 529 savings account means my child won’t get federal financial aid.
Reality: The money in a 529 plan is not the student’s asset, but the parent’s and is treated as such in terms of federal financial aid. These funds are considered when determining federal financial aid, but have minimal impact: eligibility for FAFSA can be reduced by no more than 5.64% of a 529 plan’s account value each academic year. In addition, a grandparent or other account-holder’s income is not factored into financial aid eligibility, although withdrawals from the account for college may be considered student income.
Myth: Contributions and withdrawals can only be used for 4-year colleges.
Reality: Withdrawals from a 529 savings account can be made tax-free for qualified education expenses for in-state and out-of-state colleges, private and online universities, community colleges, trade or vocational schools, 2-year colleges, and even many schools abroad, as long as your student is enrolled at least part-time.
Myth: It costs a lot of money to open an account.
Reality: With The Education Plan, New Mexico’s 529 education savings plan, you may open an account with as little as $1. Contributions can be made at any time, in any amount, whether you do so via lump sums, checks, rollovers, or automatic withdrawals from your paycheck. You control the account, including the amount you choose to add to the fund, as well as when and how.
Myth: Only a parent can open an account for their children.
Reality: Any United States citizen over 18-years-old with a Social Security number or tax ID number and a United States residential address may open a 529 education savings account. The beneficiary and the account holder do not need to be related. That means family and friends can open accounts for your children too.
Myth: I am required to invest in my own state’s plan.
Reality: You may open an account in any state, not necessarily the one in which you reside. Each plan differs, however, in terms of rules and tax breaks. For example, if you are a New Mexico resident, you can claim a state tax deduction on 100% of contributions to your 529 plan from your state taxable income every year. New Mexico is one of only four states that provides an unlimited state tax deduction for contributions to its 529 plans.
Myth: It’s too late to open an account. My child is already in high school.
Reality: It’s best to start early, but it’s never too late to open a 529 education savings account. Anyone can open an account at any time in their child’s life, with any amount, with contributions from any person. Encourage grandparents, other relatives, and friends to contribute, and watch your savings grow during those high school years as investment earnings are reinvested automatically back into the account.
Myth: 529 plans are only for children.
Reality: There is no age limit to who can open, contribute, or withdraw from a 529 savings account for qualified education expenses. Maybe your child decides to go to medical school at age 25, you decide to finish your graduate degree, or Grandma wants to take classes part-time at the local community college. All are possible with 529 education savings accounts.
Myth: When my child turns 18, they can spend the money on anything they want.
Reality: Savings in a 529 account are your assets, not your child’s. The account holder controls the funds. Even when your child turns 18 years of age, they have no legal right to the money. So, don’t worry about them using that money for expensive personal items such as a wide-screen television or a trip to Europe. Those funds are yours to distribute and are tax-free when used for qualified education expenses.