If you’re a parent or a grandparent, you’ve probably worried about how you’ll help pay for your children’s college education. With the price of tuition outpacing the general inflation rate, planning for college has become a more critical component of financial planning than ever before. A 529 plan can be an immense help when it comes to paying some of these expenses, but it can depend on the plan you choose and how early you begin investing in it.
529s can help you save
In a nutshell, a 529 plan allows you to accumulate funds to help pay for a designated beneficiary’s qualified higher education expenses at an eligible educational institution. The plan gets its name from the section of the Internal Revenue Code (Section 529) that outlines its provisions. They are generally available to anyone, regardless of a family’s income level, and they’re tax-advantaged to boot, meaning that investment earnings from the plan are allowed to grow federal income tax-free, and withdrawals used to pay for qualified education expenses are also tax-free.
There are two types of 529 plans: prepaid tuition plans and college savings plans. Both are generally sponsored by state governments and administered by one or more investment companies.
Prepaid tuition plan
- Contributions are made to a qualified trust
- Lets you lock in tomorrow’s tuition at today’s rates
- Allows you to purchase a number a course units/academic periods that are redeemed when a beneficiary becomes old enough to attend college
College savings plan
- Lets you choose from a menu of investments typically managed by mutual fund companies
- Amount available to help pay higher education expenses depends on growth in account
- Offers more return potential, as well as risk
Eligibility and withdrawal rules
Generally speaking, everyone is eligible to contribute to a 529 plan – it’s not limited by age or income. Depending on the program, you could contribute upwards of $200,000 on behalf of a beneficiary. It’s a good idea to check with your program sponsor for details on how various factors such as age, current education costs and projected inflation rates could influence your maximum contribution limits.
As previously mentioned, tax-free withdrawals from the account may used to pay for qualified education expenses such as tuition, fees, books and supplies, among many other options. And it’s not just for undergraduate education – they may be used for graduate school expenses, as well! Withdrawals that are not used for higher education expenses are subject to ordinary income taxes – either at the owner’s rate or the beneficiary’s rate – and an additional 10% penalty tax.
Is a 529 your best option for saving for college?
Not always. A 529 plan can be a great tool, but it’s best for those who are relatively certain the beneficiary will eventually attend college. If the original beneficiary of the account opts not to pursue higher education, the account owner may change the beneficiary, but only if the new beneficiary is a member of the same family. Currently, there’s no federal income tax to transfer the account, but this could change.
To read more about what to consider when saving for college, including the 4 reasons why it’s worth the effort to save and invest specifically for your children’s college education, check out Bruce Helmer’s book: Real Wealth: How to make Smart Money Choices for what matters most to YOU.
Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investment in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.