December and January are probably the most popular months for personal finance bloggers such as ye olde Dime here. After all, the transition into the new year is ripe for financial advice. We’re guessing you’ve already been bombarded by reminders to contribute to your IRA, use (or lost) the remaining dollars in your flexible spending account, and make charitable donations—all in the name of personal finance.
Another common topic is the 529 plan, something typically held in high esteem by parents with college ambitions for their children. But 529 plans aren’t just for parents. In fact, you can set up a 529 plan for just about anyone: siblings, children of friends, yourself (hey, treat yoself, right?).
OK, so that’s great and all, but first thing’s first: what the heck is a 529?
Created by Congress to help offset the cost of higher education, a 529 plan allows individuals to save money for college. Similar to a 401(k), contributions are invested in the stock market with the idea that the account’s earnings will grow and compound over many years. The earnings grow tax-free, and distributions are also tax-free as long as long as they go toward qualified educational expenses. In some states—like Colorado, for instance—contributions are also tax-deductible (only for state taxes unfortunately, but hey, anything helps).
In many states, the 529 plan is composed of two parts: saving for college using tax-free growth, and not paying taxes on the contributions. In order to receive a tax deduction on your state taxes, you’ll have to use Colorado’s state-sponsored 529 plan, or more specifically, the Direct Portfolio College Savings Plan. Contributing to another state’s 529 plan, while totally allowable, can’t be used to reduce your taxable income (*sad horn).
As we’ve already established, anyone can open a 529 plan for someone else. In fact, they’ve become more and more popular as a replacement for traditional gifts…ideal for when you don’t know what to buy your eight-year-old niece who appears to have everything. OK, so starting a college fund for an eight-year-old may seem kinda boring; but, just remember—a 529 plan also won’t break, fall out of trend, or depreciate over the long-term. And when she turns 18 and is ready to buy her first set of books for college, she’ll be pretty happy to dip into the savings you’ve accrued for her. The gift of a 529 just needs time to grow to be appreciated.
You can set up a 529 for yourself, too. This works well even if you want to use the money almost immediately to pay for qualified educational expenses. Case in point: you can contribute to Colorado’s state-sponsored 529 plan on or before December 31st to claim it for the current tax year. According to the rules, your contribution has to remain in the plan for seven business days. However, after that, you can pull the money out in 2018 to pay for your spring semester’s expenses—tuition, books, laptop, etc. It’s a little clever maneuvering to avoid paying the Colorado income tax of 4.63% on the money used to pay for college expenses.
Have we convinced you yet? 529s are incredible tools to help save for college, both for yourself, and for others in your life. As with everything though, do your due diligence before you open one. That is, read up on the benefits, drawbacks, rules, and tax deductibility for your respective state. One thing is certain—college is becoming more and more expensive. But at least there are tools like the 529 plan that are here to help.