When it comes to saving for college, the most powerful weapon in our arsenal may be the 529 plan. Some folks can't imagine saving for college any other way.
And what's not to love? With a 529, your investments grow tax-free at the federal level (and in some cases at the state level, too), and your earnings won't be taxed when you withdraw that money to pay for college.
But there's a downside to 529 plans. Overfund a 529, and you'll be stuck paying taxes plus a 10% penalty on any earnings that are withdrawn but not used for qualified educational expenses. Putting money into a 529 requires you to be a fortune-teller of sorts: You'll have to estimate how much your beneficiaries will need for college to avoid going overboard. It's a daunting prospect, which helps explain why 97% of American families don't use 529 plans to save for college.
If you're worried about the risks involved in opening 529 plans, recent changes to these plans may work out in your favor. The recently enacted PATH Act has made investing in 529 plans less restricted and more practical.
Computers are a qualified educational expense
Although many would argue that securing housing near campus is essential to attending college, room and board do not count as educational expenses and therefore can't be paid for with funds withdrawn from a 529. Until recently, the same held true for computers, despite the fact that the average college student can't function without one. But now computers do count as a qualified educational expense, which means you have more flexibility in how to spend the money in your 529.
Of course, there is a catch. If you withdraw money from a 529 plan to pay for a computer, it must be one that's used primarily by one of the plan's designated beneficiaries while that person is enrolled in an eligible educational institution. But as long as you meet those criteria, you can also use money from a 529 plan to purchase not only a computer, but also peripheral equipment such as printers and software. Oh, and tablets count too, which means you can upgrade your iPad to the latest addition with impunity.
Tuition refunds can be redeposited without penalty
The new 529 rules also allow plan holders to redeposit refunds from an educational institution free of tax. Say you've paid your tuition, but your child falls ill and needs to withdraw for a semester. From a tax perspective, you no longer have to worry about losing out. So long as you redeposit your refund into your 529 plan within 60 days of receipt, you won't incur a penalty.
Accounts for the same holder and beneficiary don't have to be combined
If you hold more than one 529 account for the same beneficiary, you get more flexibility in managing and reporting your earnings. Under the old 529 rules, plan administrators aggregated all accounts with the same account holder and beneficiary of record to calculate the earnings portion of a given distribution. Going forward, the earnings portion of any given 529 plan distribution will be calculated on an account-by-account basis, which means you can better plan for withdrawals that come with tax implications.
While the rules governing 529s are still fairly rigid, these changes are a step in the right direction. Of course, the ability to use 529 funds to purchase a laptop may not be enough to sway anti-529ers into opening their own plans, but it's nice that those who already hold accounts get a bit more wiggle room.
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