529 College Savings Plans Explained

Personal Finance
a young woman is able to take a test at school thanks to a 529 college savings plan

The decision to start saving for their child’s education is an important part of being a parent. Do you save for them? Can you afford to save for them? How much can you afford to save? How should you save? As you know, the questions start piling up. Why not start here, with some information about 529 college savings plans.

Two Different Types of 529 Plans

The prepaid 529 college savings plan allows you to actually prepay some or all of the tuition costs of a particular public college. Later on, you can convert your prepaid plan for use at any institution in the country. There are also separate prepaid college savings plans which you can invest in if your child decides to attend a private college.

The regular 529 college savings plan is an investment account which you pay contributions into, much as you would with a 401K or an IRA. The value of this account may rise or fall, depending on the state of the market and what types of investments the managers choose. Colleges are not allowed to offer this type of savings plan, so you have to work together with a plan manager in order to enroll.

Federal Tax Advantages

While you’re not allowed to deduct the contributions that you pay into a 529 college savings plan, these plans offer you significant tax advantages because when the investment increases in value, the tax on that increased value is deferred. Later, when you withdraw money out of your 529 account for your child’s education, that distribution is free of federal taxes as well as long as it is for approved college expenses.

State Tax Advantages

It’s worth your while to investigate what types of tax breaks your state offers for its own public 529 college savings plans. There are no residency requirements for many 529 plans therefore if there aren’t good benefits from your state for these types of plans, you can choose another state’s plan.

529 Plans are not Unlimited Tax Shelters

If you happen to have abundant resources, you will not be able to use multiple plans as a way to shelter large amounts of investment earnings from income taxes. While you can justify setting aside up to around $300,000, you can’t simply use this system for unlimited tax protection. Each state keeps a close eye on its 529 college savings plans and you may get penalized if it appears that you’re setting aside more funds than an education would require. Not only that, when you withdraw the money for non-education expenses, you’ll be subject to taxes and a 10% penalty.

Remaining in Control

Unlike other college saving plans, such as a custodial UTMA account, a 529 college savings plan does not give any rights to the beneficiary. The donor remains in control of the account, and you are the one who decides when the funds in the 529 college savings plan will be distributed to the student. In addition, you are actually allowed to close the account and take back all your money (plus interest) if you decide to, but there are penalties. The earnings which have accrued in the account will be subject to income tax as well as a 10% non-qualified withdrawal penalty.

529 Plans are Flexible and Easy to Maintain

During the years that you make contributions to a 529 college savings plan, you will not receive any 1099s. You will not be asked to make any investment decisions, since investments in a 529 college savings plan are controlled by either the treasurer’s office of the state that it is based in, or by a private investment management firm. Furthermore, you may change the beneficiary of a plan, and you may also roll over a plan from one state to another (within certain guidelines). If you chose to, you could live in Nevada, invest in a 529 college savings plan in Connecticut, and use it to pay for your child to go to school in Florida!

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