How to Open a 529 Plan

Mark KantrowitzBy Mark KantrowitzBy Savingforcollege.com

This step-by-step guide to opening a 529 college savings plan makes the process easier for parents and grandparents to save for college.

[See also separate specific step-by-step guides to opening a 529 plan in California, Florida, New York and Texas.]

1. Choose a 529 Plan

Parents and grandparents can invest in any state’s 529 plan, not just their own state’s 529 plan, so they should shop around.

Nevertheless, they should consider their own state’s 529 plan first, because 34 states and the District of Columbia provide a state income tax deduction or tax credit on contributions to the state’s 529 plan. However, residents of Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana and Pennsylvania can get a state income tax break for contributions to any state’s 529 plan.

Ultimately, the goal is to maximize the total amount of money in the 529 plan account when the beneficiary is ready to enroll in college. Thus, families should consider the 529 plan’s return on investment and costs, in addition to tax benefits, when choosing a 529 plan. Minimizing costs is the key to maximizing net returns.

Thus, families should also look at which 529 plans have the best performance and the lowest fees. Consider also the 5-cap ratings, which rate the best 529 plans for state residents and non-residents.

Low fees matter more than tax breaks when the child is young, since the fees are charged every year, while the tax breaks apply only to that year’s contributions.

Other helpful resources include a directory of detailed information about the various 529 plans, a list of the most popular 529 plans and a 529 plan comparison tool.


2. Determine the Type of 529 Plan Account

There are two main types of 529 plan accounts: individual accounts and custodial accounts.

Most families will open an individual account with a parent as the account owner and a child as the beneficiary. Everybody can contribute to a parent-owned 529 plan account, including parents, grandparents, aunts, uncles and other relatives.

Typically, only one parent can be the account owner. If the child’s parents are divorced, the account owner should be the parent who will be responsible for filing the Free Application for Federal Student Aid (FAFSA). If this parent has remarried, it is best for the account owner to be the child’s biological parent, not the stepparent.

If money from a custodial bank or brokerage account, such as an UTMA or UGMA account, is used to fund a 529 plan, then the 529 plan should be set up as a custodial 529 plan. With a custodial 529 plan account, the child is both the account owner and the beneficiary. Since the child is a minor, a custodian will manage the account on behalf of the child until the child reaches the age of majority. Note that the beneficiary of a custodial 529 plan account cannot be changed.

529 plans that are owned by a dependent student or the student’s parent are treated more favorably by financial aid formulas.

If the grandparents open a 529 plan account with themselves as the account owner, it can hurt the grandchild’s eligibility for need-based financial aid. Although a grandparent-owned 529 plan is not reported as an asset on the Free Application for Federal Student Aid (FAFSA), distributions from a grandparent-owned 529 plan count as untaxed income to the beneficiary on a subsequent year’s FAFSA, reducing aid eligibility by as much as half of the distribution amount. There are, however, a few workarounds for a grandparent-owned 529 plan that can fix the impact on financial aid eligibility.


3. Complete the 529 Plan Application

When you are ready to choose a 529 plan, the enroll now tool helps you open an account online. Just click on the “Enroll Now” button adjacent to the 529 plan’s listing. It will take you directly to the online application form for opening a 529 plan account.

Other options for setting up a 529 plan account include visiting the 529 plan’s web site to download an enrollment kit.

Most 529 plan account applications will require the following information:

  • Name of the account owner
  • Name of the beneficiary
  • Personal information about the account owner and beneficiary, including their mailing address, telephone number, email address, date of birth and Social Security Numbers (SSN) or Individual Taxpayer Identification Numbers (ITIN).

The 529 plan account application may also ask for the name and personal information of a successor account owner, in case the original account owner dies.

The 529 plan account application may also ask you to pick an initial set of investment portfolios.

If the application form is confusing, call the 529 plan’s toll-free number to ask questions. If you ask questions by sending email to the 529 plan, do not include account numbers, passwords or other personal information in the email message.


4. Fund the 529 Plan

There are several ways of depositing money into a 529 plan. These include mailing a paper check to the 529 plan and transferring the money electronically from your bank account.

All 529 plans allow you to set up automatic contributions from your bank account. You will need to specify the contribution amount and the contribution frequency (e.g., biweekly, monthly, quarterly, annually). The 529 plan will also need the bank routing number and account number for your account and a voided copy of a preprinted check or preprinted deposit slip.

Some 529 plans can set up automatic contributions through payroll deduction from participating employers.

Automatic investment makes it easier to save, since you don’t have to remember to make a contribution to the 529 plan.

Other options include a rollover from another 529 plan, money from a Coverdell education savings account or money from the redemption of a qualified U.S. Savings Bond.

Minimum contribution amounts vary by state. Some states have no minimum contribution amount. Automatic contributions, including payroll deductions, typically must be at least $15 or $25.

There are no annual contribution limits for a 529 plan, but you can give up to $15,000 ($30,000 as a couple) each year without incurring gift taxes or using up part of your lifetime gift tax exclusion. 529 plans provide 5-year gift tax averaging, so you can give up to 5 times as much money ($75,000 or $150,000 as a couple) in a single year and have it treated as though it were given over a 5-year period.

Cumulative contribution limits vary by state, ranging from $235,000 to $529,000, and are periodically adjusted for inflation. After a 529 plan account reaches this balance, it can still earn interest and appreciate in value, but no additional contributions will be accepted. Most people do not reach this limit.

Many people start off with a small, automatic monthly contribution and increase the amount after a few months. If your goal is to save about a third of the future cost of a public college education, start saving $250 per month from birth. If you can’t handle that big a contribution, start off with what you can afford.


5. Choose Investments for the 529 Plan

After the 529 plan has been opened and some funds have been deposited into the 529 plan, it’s time to choose investments for the 529 plan. The number of investment options is limited, making it easier to choose.

Most people invest in an age-based portfolio, which starts off with an aggressive mix of investments (e.g., mostly stocks) and gradually shifts to a less risky mix of investments as the child approaches college age. If you start saving for college soon after the child is born, an age-based portfolio is a good starting choice. You can change the investment approach later.

Some 529 plans have just one age-based portfolio, while others have aggressive, moderate and conservative age-based portfolios. These portfolios usually differ according to the initial percentage stocks (e.g., 100% equities, 90% equities or 80% equities) and the final percentage stocks (e.g., 30% equities, 20% equities or 0% equities).

Most 529 plans also offer static portfolios which may involve single-fund portfolios or multi-fund portfolios, as well as a money market portfolio. Options may include bond funds, U.S. large-cap, mid-cap and small-cap index funds and foreign stock funds.

You can change your investment strategy twice a year.


Extra Tips on Ways to Save for College

There are several ways you can help your 529 college savings plan grow faster.

  • Consider opening a college savings reward credit card. These credit cards give you cash back that can be swept into your 529 college savings plan.
  • Give the gift of college instead of traditional holiday and birthday presents.
  • Whenever you get a raise, increase the amount you save for college.
  • Whenever your child no longer needs diapers or daycare, redirect the amount you were previously spending to their 529 college savings plan account.
  • If you get a windfall, such as a big bonus, an inheritance or a big income tax refund, direct at least half of the money toward your 529 college savings plans.
  • If your state provides a state income tax break based on contributions to the state’s 529 plan, reinvest the tax savings in the 529 plan.


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