Saving for college these days is a daunting prospect. Estimates suggest the average annual tuition for a public school will cost about $44,000 by 2030. Factor in fees and other expenses, and that means a four-year degree will cost about $200,000, far outpacing expected salary increases.
Other living expenses will also far exceed wage growth, so it's more important than ever to start saving early. A 529 plan provides a mechanism for saving and some good tax benefits. Here's what you need to know.
What is a 529 plan?
The concept of a 529 plan started in 1986, and later the Internal Revenue Service added it to Section 529 of the Internal Revenue Code, hence the name. The Securities and Exchange Commission refers to 529 plans as "qualified tuition plans." There are two types, education savings and prepaid tuition, and every state and the District of Columbia offers at least one.
Pros and cons
The educational-based plans are structured on a tax-deferral basis, and if used for qualified education purposes, are not federally taxed when withdrawn. That's a great advantage, but it's important that you evaluate the pros and cons to ensure the decision is the right investment for you.
- The earlier you start, the more valuable the investment, meaning more bang for your buck. Over time, it becomes more conservative, to safeguard it as college age comes closer.
- Tax-free interest means the longer the investment, the better the return.
- Special tax savings vary by state, along with the terms of the plan.
- Contributions are often tax-deductible.
- Withdrawals for educational purposes are not subject to federal income tax, and in many cases, nor state income taxes.
- It's possible to change the beneficiary if the original one doesn't need the money. For instance, if you've saved for one child in a 529, but that child doesn't attend college, you can shift the funds to another of child to use for college.
- Fees can lower your returns, however. Check each investment option carefully for individual fees, enrollment or application fees or other charges that lower your return.
- There can be some risks associated with 529 plans.
- Money not withdrawn for college or qualified tuition at elementary or secondary schools will be subject to federal tax penalties, currently 10%.
- Be sure to understand any restrictions that may not work for your family or beneficiary.
Before deciding, it's important that you understand any other account terms associated with 529 plans you're considering. Terms vary from state by state, but you don't necessarily have to live in the state in which you open an account. There may be some restrictions or tax benefits to a 529 plan in your home state, however. The educational savings accounts come with some great tax benefits, but again, it's essential that you do your homework.
What to look for in a good 529 plan
If you decide on one, these are some of the most important factors to look at when determining the best ones for you.
- Contribution limits.All is not equal when it comes to the limits that state regulations permit. Some are as low as $1,000 while others grant unlimited tax breaks for contributions. In other words, if you contribute $5,000 to your child's 529 and you live in Rhode Island, you'll get a dollar-for-dollar deduction only up to $1,000. If you live in West Virginia, you'll be granted unlimited tax breaks. Be sure to check your state's laws.
- State taxes.There are states that allow only residents to get the tax break, while others give it even if the taxpayer has invested in a 529 plan in another state.
- Inbound rollovers. Some states allow taxpayers to enjoy a tax deduction if they roll an outside plan into their state's 529 plan.
- Outbound rollovers. Several states require taxpayers rolling funds out of their state's 529 plan into another state to repay deductions or credits they received at the time of the transfer.
- Investment options.Some 529 plans have minimal investment options while others have dozens. See see which stock, bond and money-market funds are part of an individual plan so that you understand your investment options during the course its life.
Another thing to think about is participating colleges. It's a good idea to know ahead of time which schools are eligible under the 520 rules.
At Guided Choice we believe in helping people reach financial freedom, and we constantly work to do just that. We are dedicated to bringing you insights and information that help you make better, more informed decisions to improve your future.
Everything you need to know about 529 plans
Saving for college these days is a daunting prospect. As college costs far outpace inflation and wage growth, parents today rightfully worry about how to pay for their child’s education. A 529 plan provides a mechanism for saving and offers some good tax benefits as well.