It’s no secret that college costs are spiraling upward. Between 2000 and 2015, the average cost of a single year at a four-year public school—including in-state tuition, fees, and room and board—jumped nearly 70%, according to a survey by the College Board.1 And the price of a year at a private school rose more than 40%.
That amount doesn’t even include costs like books, supplies, transportation and other expenses. Altogether, four years at a public school now costs roughly $100,000, while the bill for a private education could run to twice that amount or more.2
These daunting figures are why so many people turn to special tax-advantaged accounts—called 529 plans—to help save for college. These state-sponsored programs allow parents, relatives and friends to contribute money to support a child’s (or any person’s) college education. The money is invested until it’s time to start paying school-related bills, and the investment income isn’t subject to federal income taxes (and possibly state taxes). That makes it easier to build savings.
But there’s a caveat: The tax benefits apply only if you spend the money on “eligible” expenses.3 In broad terms, you can think of these as the essentials—such as tuition and fees, textbooks, room and board, and even computers and Internet service—so long as they’re required by the school. The tax penalty for spending on ineligible items can be steep—you’ll have to pay income taxes and a 10% penalty on any of the investment gains you’ve spent.
So although 529 plans remain a valuable—even an essential—tool for saving for college, they also have their limitations. If you’re concerned about covering all of costs of college, it’s worthwhile to consider some common expenses that aren’t covered by 529 plans, as well as some options for saving for them.
- Living off campus? You can use money from a 529 plan to pay for off-campus rent and groceries—but only up to a point. Anything you spend above what it costs for a student to live and eat on campus won’t be considered an eligible expense by the IRS. To find out more, check with the school’s financial aid office and be sure to keep your receipts.
- Planning to travel? You can’t use 529 funds to pay for the costs of traveling to and from college or a trip home for the holidays. Spring break trips are also out. So are any costs arising from commuting, public transportation and parking fees.
- Studying abroad? You can use 529 funds to pay for education-related expenses and room and board overseas—but the amounts will be based on the school’s budget calculations and won’t reflect currency differences. Weekend trips aren’t eligible. You can also use 529 funds to pay for tuition at an overseas university. As of the 2015 school year, 411 overseas institutions were eligible, according to the office of Federal Student Aid. Check here to see if a particular school is on the list.
- Medical expenses? You can’t use 529 funds to pay for medical bills.
- Killing time and socializing? You can’t use 529 funds to pay for entertainment. That applies to on-campus movies, concerts and sporting events, as well as any costs related to participation in clubs, sports or groups like fraternities and sororities.
- Furnishing a room? You can’t use 529 funds to pay for bedding, furniture, decorations, lamps, storage, TVs or microwaves for a student’s room. Nor can you use such funds to buy clothes.
This list doesn’t cover everything, but it offers a glimpse at some of the many costs that can pop up. To be clear, 529 plans can definitely help you cover the lion’s share of your college bills without risking any tax penalties.
But what about the rest? Schwab has a few options to help.
- Individual investment account. A regular investment account can be an important savings tool. You can also use an investment account with a disciplined saving strategy called dollar-cost averaging, whereby you invest a fixed dollar amount on a regular basis. That can help you automate your contributions and build your savings over time.
- Custodial account. With a custodial account, an adult can set up and manage an investment account on behalf of a minor. As soon as the child reaches age 18 (or, in certain states, 21), he or she can take full control of it. Note that if large amounts of money are involved, there can be tax issues as well as a possible impact on college financial aid.
1 “Tuition and Fees and Room and Board over Time, 1975-76 to 2015-16, Selected Years,” College Board.
2 “Trends in College Pricing 2015,” College Board, 2015.
3 “IRS Publication 970, Tax Benefits for Education,” 2015.