The price of a college or university education keeps going up, so it’s important that any planning we do for those future expenses is done wisely. This episode features what we consider to be the best savings and investment account available to save for higher education, the 529 plan. And the good news is that it’s an approach that even people in higher income brackets can use because there are no income restrictions with these plans. Listen to learn why a 529 plan is such a great investment vehicle, how 529s receive a triple tax benefit, and to hear the most common questions we receive about them.
Outline of this episode
- Your views of saving for college are often impacted by your past experience [0:57]
- The average cost of college — and it continues to rise [2:18]
- Why the 529 plan is the best way to save for college [2:21]
- A minivan vs a Ferrari: An example to help you understand [4:38]
- Tax breaks on 529 plans are pretty great [7:17]
- The only limits you need to be aware of on amounts contributed to 529s [11:00]
- The most common questions about 529 plans [18:57]
What is a 529 plan?
A 529 plan is similar to other investment accounts you might be familiar with already, such as a 403b or a 401k. Like those accounts, the money you contribute to a 529 plan can be invested as you choose in most cases and is considered a tax-deferred account. The difference comes when you go to use the money in the account. If the money you withdraw from a 529 plan is used for qualified educational expenses (more on that later), then the withdrawals you make are tax-free. So you’ve not only made a return on your contributions to the 529, you’re able to use the money without any of it being taken away by taxes.
In Michigan, you also receive state income tax deductions for making 529 contributions. The amount of tax deduction you can claim depends on your filing status. If you are single, you can deduct up to $5,000 worth of your contributions. If you’re married, you can take a deduction for up to $10,000 worth of contributions.
The Ferrari of college savings accounts has triple tax benefits
To better understand how 529 plans work, we liken non-tax-advantaged the college savings vehicles to a minivan and the 529 plan to a Ferrari. Let’s say that both vehicles start the race at the same time and both drive around the track for the same amount of time. The Ferrari is going to complete more laps around the track because it’s a more powerful vehicle. The same is true of a 529 plan when it comes to saving for college. This “power” happens in part, because of its triple tax benefits.
The 1st tax benefit is that a certain amount of 529 plan contributions can be deducted for state income taxes. Considering that Michigan has a 4.25% tax rate, that’s $425 per year you save by making a $10,000 contribution.
The 2nd tax benefit is tax-free growth of the investments inside the account. Since you’re able to choose your own investment options as you would with a 403b or 401k, those returns can be substantial over time.
The 3rd tax benefit is the 529 provides for tax-free withdrawals when the proceeds are used for qualified education expenses. What expenses are considered to be qualified expenses? Tuition, room and board, computers, books, supplies, and even a certain amount of student loan repayments.
There are two 529 plan options in Michigan
Utilizing a 529 plan to save for college is powerful and there are two ways to go about it in Michigan. The most common 529 plan is the MESP (Michigan Education Savings Program). It’s a savings and investment account that you manage yourself, choose how to invest, and choose how to spend in the future for qualified educational expenses. And if you’re not into devising an investment strategy yourself, there are age-based investment approaches that can be applied on your behalf. There are considerations and drawbacks to be aware of, so be sure to listen to get all the details on the MESP.
The second 529 option is the MET (Michigan Education Trust). It’s a prepaid tuition plan and Michigan is one of only 12 states that offer a plan like this. The MET enables account holders to buy future college credits at today’s prices. This can be done in two ways, through a full-benefits contract, which can be used at any public Michigan school, or through a limited-benefits contract, which pays tuition of up to 105% of the Michigan public school average.
There are pros and cons to each of these 529 plans, which we cover in detail on this episode.
Resources & People Mentioned
- Download our “College Planning – 529 Plan FAQs” resource
- A blog post we wrote on 529 plans
- The Michigan Education Savings Program website: https://www.misaves.com/
- The Michigan Education Trust website: https://www.michigan.gov/setwithmet/
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