Even though your child may still be in diapers it is not too soon to begin to think about his or her educational future. One of the best ways to save for a college education is to consider the 529 plan offered in your state. 529 plans offer you additional benefits during tax time each year. Each state offers some version of the plan, and often several options are available. Many colleges and universities offer 529 plans, so you are not confined to only using your state’s offerings.
The 529 college savings plans come in two designations. One is a pre-paid plan and the other is a college savings plan. The 529 college savings plan grows tax free until it is withdrawn for use on educational expenses. The 529 prepaid option allows you to lock in the current cost of tuition at your chosen university and make payments toward this cost. Pros and cons exist with both types of 529 plans so use the following information to decide which is the best choice for you.
The plans are named after a portion of the Internal Revenue Code with the IRS. This section is 529. The 529 section was enacted in 1996 to extend tax free benefits to parents who wanted to contribute to tuition savings programs. In 2015 many of the definitions were updated to include new technologies and educational expenses. The last update was made in 2017 allowing parents to place money into a 529 for use in paying private school tuition for K-12 schooling.
It is a prevalent myth that you are limited to your state’s 529 offerings. In fact, you are welcome to pay into any state’s 529 plan in the U.S. If you live in Colorado it is perfectly legal to purchase a 529 product from Maryland, and then later send your child to school in Florida. Currently, 6,000 colleges accept the 529 plans and hundreds of foreign universities participate as well. Each 529 plan will look different from one state to another. This is why it pays to compare benefits and shop around.
When you invest money into the 529 plan you enjoy numerous tax benefits. Some of those tax breaks include:
With this type of 529 plan the money you pay each month is invested on your behalf. This means the value of your savings plan fluctuates with the market. Other than an initial required amount of money to set up the account monthly deposits are not required. Many parents only deposit money into the account for special occasions such as birthdays, significant milestones or as a holiday gift. Others like to set up an automatic transfer each month, so the money goes directly into the account. Most 529 plans allow you to customize how you pay and the flexibility to change how you invest the money if you wish.
As the name implies, you pay into the plan at the current tuition rate. If the current tuition is 40,000 for four years of attendance, then this is the amount fixed or locked into your plan. The downside to this is if the cost of tuition lowers and you are still paying into the higher priced plan. Luckily, any remaining money after your child attends school is able to be converted. Many private colleges offer this type of savings program. The catch is that your child must attend this school. Schools are allowed by law to offer prepaid plans, but they cannot issue the investment savings plans.
Once your child reaches college age, he or she withdraws the amount to put toward tuition, educational fees, supplies, room and board and other educationally related expenses. If the money is withdrawn to be used for any other non-educational reason, there is usually a penalty of some sort. The usual rate is 10 percent, but each policy assesses its own penalties and fees for such withdrawals. Most plans do not allow students or their parents to use the funds to pay student loan debt.
Depending on your 529 plan you elect how the funds are disbursed, either directly to the school, to the student, or to a beneficiary. Keep in mind, depending on the state in which you reside, you may have to report your annual contributions to the plan on your tax returns.
Most 529 plans have numerous provisions in case the money is not used as planned. Suppose your child receives a large scholarship or is accepted into a military academy. In these instances, you can withdraw the money to use for yourself on non-educational expenditures if the following circumstances apply:
If there is money left over in the account, and none of the above stipulations are true, withdrawing the money results in a penalty. Avoid this penalty in one of several different ways. One way is to change the name of the beneficiary to another family member, or to simply keep the funds in the account until your child decides whether he or she wishes to pursue a graduate degree. If your child is disabled, roll the money over into a 529 ABLE plan which was designed specifically for students who are disabled. You can withdraw up to $10,000, tax free, if you use it for tuition at a qualifying institution.