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A Guide to 529 College Savings Accounts!

Quinton Cannon | Financial Coach | The Financial Clinic

Robert F. Smith made national headlines in May when he announced that he would assume responsibility for the student loans of the entire graduating class of 2019 at Morehouse College. The graduating seniors were momentarily in shock before erupting with celebration. At the same time, college students – future, current, and prior – all around the nation surely felt envious as the story dominated their newsfeeds and social media accounts.

Just a few weeks before, Elizabeth Warren’s proposal to erase a significant portion of outstanding student loan debt sparked conversation about how different people’s financial situations would look if they were ridden of their student loans.

Notwithstanding the exciting (or envy-invoking) headlines about loan forgiveness, it’s critical for future students to save for school. As a financial coach, I often tell people that although we hope that relief of some form is on its way for students and borrowers, it is wise to plan for the future with the assumption that college is going to be expensive and that students will need to find a way to pay for it. So, when possible, it is a good idea for prospective students and their families to start saving now.

529 Plans

An excellent way for many families to save for college education is with 529 plans.

However, in my experience talking with customers, friends, and family about paying for college (yes, I am that weird person who talks to you about this kind of thing at parties), I have found that most people do not know about these plans or their benefits. When people do know about them, they often don’t fully understand how they work and/or have a few misconceptions.

So, let’s talk about what 529 plans are and analyze a few common myths surrounding them.

Why the Name?

Like 401(k) retirement accounts, 529 plans get their strange name from a section in the Internal Revenue Code 26, in which this particular education savings plan is defined. (The IRS has never had a reputation for using memorable or fun names).

What Are 529 Plans?

Also, like 401(k) accounts, 529 plans exist to incentivize Americans to save their future by providing tax benefits to those who use them. There are two types of 529 plans: education savings plans and prepaid tuition plans.

  • An education savings plan allows participants to save in an account where their money can be invested and subsequently withdrawn without the account owner having to pay taxes on gains (as long as the funds withdrawn are used for qualifying education expenses).
  • A prepaid tuition plan allows participants to purchase future credits at participating schools for what those credits would cost today.

Education savings plans are much more common – while almost all states offer an education savings plan, only 18 states offer prepaid tuition plans, and as of last year only 11 of those were accepting new enrollees. So, in this post, I will focus on education savings plans.

How Do 529 Plans Work?

529 education savings plans generally consist of an investment account in which enrollees can choose what type of portfolio they wish their money to be invested in. They can contribute to the plan as frequently (or infrequently) as they like.

When somebody enrolls in a 529 plan, they can either do so for themselves or for a beneficiary (i.e. somebody other than themselves that they are saving for). If they have multiple beneficiaries for whom they would like to save, they can enroll in a 529 plan for each one – it is not possible to have multiple beneficiaries on one plan. When the person for whom the plan is intended needs to use the money, it is pulled out of the 529 plan and used to cover “qualified expenses” (including, but by no means limited to, college tuition). A penalty is charged when 529 accounts are used for non-qualified expenses.

There is no uniform 529 plan across the country. Instead, states are responsible for offering and administering their own 529 plans. Each has its own incentives and benefits – some offer better deals to enrollees than others. Utah and New York, for example, have received a lot of national attention for their respective 529 programs.

While the default option would be to enroll in the 529 where you live, it’s actually possible (and sometimes a good idea) to enroll in a 529 plan outside of your home state.

How Do I Go About Choosing a 529 Plan?

The three main things to consider when looking at 529 plans are: additional tax benefits, fees associated with the plan, and investment options in the plan.

As mentioned above, the first plan to research is generally that of your home state. This is because many plans offer state income tax deductions to residents who participate in the plan – that is, contributing to a 529 plan can lower how much you owe in taxes at the end of the year. However, some states do not offer any tax incentive. Also, some states’ plans charge high fees and/or do not have many investment options. In either of these cases, it might make sense to research other states’ plans to find one that has low annual fees and good investment options.

Why Are 529 Plans Often a Good Idea?

Financial advisors often quote Einstein as having said, “Compound interest is the eighth wonder of the world.” While it’s doubtful that he actually said this, the point remains: money has an amazing way of growing over time and, whenever possible, it is nice to be the one earning this interest instead of paying it.

529 education savings plans provide a great opportunity to capitalize on compounding interest and put it toward something you care about. The earlier you begin contributing, the more powerful the effect of compound interest.

What if the Beneficiary on a 529 Plan Doesn’t Go to College?

If your beneficiary ends up choosing not to pursue a college degree, there are several alternatives.

529 plans can be used to pay for certain non-college expenses without incurring a penalty. For example, funds from a 529 plan can be put toward many vocational or trade schools.
The beneficiary on a 529 plan can be changed. Say, for example, that you had created a 529 for yourself but decided not to attend school; if you would, however, like your daughter or son to have the opportunity to do so, you can transfer the account to them.
You will not lose all of the money you saved if it is used for non-qualifying expenses. Although the money in a 529 plan does come with strings attached, it is yours, and you have the right to use it for non-qualified expenses. Bear in mind that if you do so, there will be a fee, and you will have to pay taxes on any of the accrued gains.

Do I Have to Use My 529 Education Savings Plan for a School in My Own State?

Many people think that funds deposited into a 529 educational savings plan must be used at a university in the state that the plan is associated with. Thankfully, this is not true. The entire balance of funds accrued in a 529 education savings plan can be used at colleges and other educational institutions throughout the country, regardless of which specific education savings plan the funds are stored in.

What Are Some Problems with 529 Plans?

Having highlighted some of the benefits of 529 plans, it’s important to recognize some of the drawbacks of these plans. These generally have to do with the way that the 529 system is set up – there is a lot of room for differences between the way states and different federal programs treat 529 accounts. Two important problems to consider are asset limits and quality of 529 plans.

Asset Limits

Many families worry about the effect that opening a 529 account will have on their access to public assistance programs as well as financial aid for school. Sadly, this is definitely a cause for concern. Although many state and federal programs specifically exclude 529 accounts when considering whether an individual or family should qualify for a certain benefit, others, unfortunately, do take 529 accounts into consideration and this can impede some individuals from accessing certain types of assistance that they need. It is frustrating that we as a nation continue to disincentivize people from investing in themselves and their future, but for the time being some programs still fall into this archaic way of thinking.

529 accounts are also considered, to an extent, in determining financial aid awards to students when they fill out a Free Application for Federal Student Aid (FAFSA). The effect is generally relatively small. However, there are some potential snags to consider – for example, 529 accounts owned by students’ grandparents are treated differently than those owned by the students’ parents.

It is worth noting that student loans often make up a significant portion of financial “aid” packages, so sometimes reduced financial aid is mostly a reduction in student loans that need to be taken out to pay for school, which is a positive.

Not All Plans Are Created Equal

Some recent news articles, such as this one, have highlighted that some 529 Education Savings Accounts are not as good of a savings option as they should be because of the high fees that they charge. For this reason, it is important to try to find a 529 plan that has relatively low fees.

Making 529s Accessible to All

Enrolling in a 529 plan for yourself or a loved one is often an excellent idea. Putting away tax-free savings and taking advantage of compound interest can make college more accessible for future students and help mitigate the crushing debt burden that the majority of college graduates are now bearing.

There are exciting initiatives taking place all over the country to expand 529 plans and increase the public’s use of them, such as the Refund529 program signed into law in New York State in 2016. However, more can and should be done to make this program more accessible to low-income families by continuing to restructure asset limits for public assistance programs and other safety nets designed to help those most in need.

Please join us in advocating for the expansion of 529 plans and a reduction of asset limit tests that impede people from enrolling in them. And while you’re at it, consider enrolling in a 529 plan yourself.

A Student Loan Free Future

By Kristen Baker | Senior Financial Coach | The Financial Clinic

Whether you just stepped across the stage and threw your cap in the air, or it’s been several years since you stepped foot in a classroom, we have some tips to help you tackle your student loans head on.

Recent Grads:  Congrats! You’ve taken your last exam, walked across the stage, and put the finishing touches on your resume. Now what?

It can be easy to get caught up in the feeling of hard-earned freedom before you start your first job. But, once the party decorations are taken down, take a minute from basking in your success to think about the future. That means taking time to get your student loans in order.

First things first, you must determine what kind of student debt you have. Is it Federal? Private?  A combination of the two? In order to determine how to deal with your student loans, you’ll need to determine what type you have. Generally speaking, there are two types of student loans: federal and private.

Federal loans are loans from the government. According to studentaid.ed.gov, the U.S. Department of Education has two federal student loan programs:

  • The William D. Ford Federal Direct Loan (Direct Loan) Program is the largest federal student loan program. Under this program, the U.S. Department of Education is your lender. There are four types of Direct Loans available:
    • Direct Subsidized Loans are loans made to eligible undergraduate students who demonstrate financial need to help cover the costs of higher education at a college or career school. Interest does not accrue on these loans while the student is enrolled at least half-time and for 6 months after they drop below half-time enrollment.
    • Direct Unsubsidized Loans are loans made to eligible undergraduate, graduate, and professional students, but in this case, the student does not have to demonstrate financial need to be eligible for the loan. Interest on Unsubsidized loans accrues from the moment the loan is disbursed.
    • Direct PLUS Loans are loans made to graduate or professional students and parents of dependent undergraduate students to help pay for education expenses not covered by other financial aid. It is important to note that unlike the Subsidized and Unsubsidized loans, PLUS Loan eligibility is based on the applicant’s credit history. Additionally, the loan liability for Parent PLUS loans lies solely with the parent(s) who applied for it – not the student – and liability cannot be transferred to the student at any time.
    • Direct Consolidation Loans allow you to combine all of your eligible federal student loans into a single loan with a single loan servicer. Other Direct loans, as well as Stafford/FFEL loans, can all be consolidated into a Direct Consolidation Loan.
  • The Federal Perkins Loan Program is a school-based loan program for undergraduates and graduate students with exceptional financial need. Under this program, the school is the lender, so eligibility requirements will vary by educational institution.  If you have questions about Perkins Loan eligibility, it is best to contact the school’s financial aid office directly.

Private student loans are often from banks, credit unions, state agencies or directly from a school. If you’ve determined that you have private student loan debt, you should contact your loan servicer to find out what options you have for repayment. Private student loans do not have regulated terms and interest rates on private loans are usually higher than federal loans. It is best to try and pay them off as soon as possible to avoid accruing a lot of interest over the life of the loan.

If you’re not sure what type of loans you have, there are a couple different ways you can track down this information. The easiest way to determine your loan type(s) is simply by calling the servicer and asking. But, if calling up a company you owe tens of thousands of dollars to doesn’t sound like an ideal way to spend your day, you can also check out your loan records on the National Student Loan Data System, nslds.ed.gov. If you know your Federal Student Aid ID (hint: it’s the login information you use for FAFSA), you’ll use those credentials to log into this system, too. If you don’t have or remember your Federal Student Aid ID, you can create a new one at fsa.ed.gov. Once you’ve logged into NSLDS, you’ll be able to see all of the federal loans you have ever borrowed. If you have any loans that are not showing up in NSLDS, it is likely that they are private loans.

Once you have discovered what type of loans you have, it is time to look into what types of payment plans are available to you. As mentioned before, private loan lenders can determine the repayment options for their loans, so it is best to contact the lender as soon as you leave school to determine when your payments will come due and what types of plans are available. If you have federal loans, the repayment options are much more varied. All federal student loan borrowers will be automatically put into the Standard Repayment Plan. In this plan, your payments are based simply on what must be paid monthly in order to allow you to pay off your loans in 120 months (10 years). While this option typically amounts to the least amount of interest paid over the course of the loan, it is not always affordable to people, especially those just entering the workforce. If this is the case for you, you should look into one of the Income-Driven Repayment (IDR) or Graduated Repayment plans. The IDR plans are all based on your income to make payments more affordable. However, because the monthly payments are lower, the length of the repayment period is much longer, up to 25 years for some plans. The Graduated repayment plan offers payments that start out lower and increase over the life of the loan, allowing for the full amount to be repaid in 10 years. While it may seem affordable at the beginning, the monthly payments at the end of a Graduated plan can be quite lofty. Because of this structure, the Graduate payment can be a good option for folks like doctors who are very confident they will have a huge spike in income within a few years of finishing school. It is a riskier plan for people going into jobs that don’t often see a huge increase until much farther into their career. Regardless of the plan you choose, below are a few best practices to consider when working on paying your loans.

  • Line up the due dates with your paycheck to ensure you’ll always have enough to cover your bill.
  • Set your bill on autopay. Not only does this remove the risk of forgetting to make the payment, but many loan lenders offer an interest rate reduction for choosing this payment method.

If an unexpected change in income occurs, be sure to communicate that with your loan servicer as quickly as possible so that you don’t fall behind! You may be able to update your payment amount or choose a temporary forbearance. Some payment plans even allow $0/month payments. While plans like this one won’t do anything to bring down the loan balance,  they do keep the loans from going into default.

Download a free Change Machine tipsheet to help you figure out which repayment plan is right for you WhichStudentLoanRepaymentPlanIsRightForMe, and check out StudentAid.gov for more in-depth information on your options!

Not-So-Recent Grads:

“What if I graduated a long time ago, but have never successfully entered or stuck with a payment plan?”

While things may be trickier if your loans are already delinquent or defaulted, there are still options.  We understand that sometimes it’s been so long, you’re not sure who to pay or how much. Luckily, no matter how long ago you borrowed them, the National Student Loan Data System will still have a record of all federal loans. If it’s been many years, the servicer of your loans has probably changed from the one you originally signed a Master Promissory Note with, so the first thing you want to do is log into NSLDS and find out who currently holds your loans.

Once you find out which company holds your loans, contact them to work out a payment plan. Generally, there are two options for defaulted loans to get back in good standing. The first is loan rehabilitation. In rehabilitation, the borrower must make 9 “reasonable and affordable” payments within 10 months. If you meet income eligibility requirements, these payments could be as low as $5/month (as opposed to $0/month on Income-Driven Repayment plans for loans in good standing). Once the 9th payment is made, your loans will return to good standing, and you can take advantage of any federal repayment option. The second option is consolidation using a Direct Consolidation Loan as mentioned before. If you choose to consolidate your older, defaulted loans, they will be paid off with the brand new consolidation loan that is in good standing. Rules and regulations around student loan default resolution are subject to change, and sometimes know the right questions to ask your servicer can be difficult. But, please don’t be intimidated! If you don’t feel like you are making progress or finding a repayment option that works for you, don’t be afraid to hang up and call back another day to speak to a different representative.

We know that thinking about paying down your student loans can be a daunting process. If you are a recent grad, it may be the first big, long-term decision you have had to make. But starting yourself on the path to becoming student loan free by getting organized and getting informed is the best way to ensure success. And just think how good will it feel to have those loans gone so that you can start using those monthly payments to save up for that backpacking trip around Southeast Asia or that house you have been looking to buy! It is only by tackling these debts head on that you find yourself on the path to a student debt-free future. So go forth, pay down those loans, and tell us all about it on Facebook and Twitter because, just like your grandma, we are always looking for new success stories to brag about!