Why 529 Plans Are A Great Way To Save For Qualified College Expenses
Grow Your Earnings and Take Withdrawals Federal Tax-Free
In its most recent survey of college pricing, the College Board reports that for the 2015-2016 academic year, the average cost of tuition and fees was $32,405 at private colleges, $9,410 for state residents at public colleges, and $23,893 for out-of-state residents attending public universities.
These numbers are in today’s dollars, so if you recently had a baby and you’re looking at college costs that are 18 years away, those prices are going to increase significantly. With all of life's hefty expenses, it's easy to put off education funding, but it's not a good idea. Most Americans will need to save for a long time to have enough to cover four years of college. If you're unsure where or how to begin, a great place to start is by looking into a 529 plan.
What Is A 529 Plan?
529 plans date back to 1986 and have become a widely used investment vehicle for saving for college. What makes the plan so attractive is that while contributions aren’t deductible, earnings in a 529 plan will grow federal tax-free and will not be taxed when the money is taken out for qualified education expenses. In addition to the federal tax break, currently there are 34 states including the District of Columbia that offer full or partial state tax deductions for contributions to a 529 plan.
There are two types of 529 plans- the college savings plan and the prepaid tuition plan. Here are some of the most important highlights of each plan:
College Savings Plan
- Allows you to build an education fund within an individual investment account. The money you contribute is invested in one or more specific investment portfolios that consist of a mix of investments that are chosen and managed by the plan’s designated money manager.
- Funds can be used to pay for qualified expenses at any college accredited by the U.S. Department of Education. This includes undergraduate colleges, graduate and professional schools, two-year colleges, and technical and trade schools. Certain foreign colleges and universities are also included.
- The plan manager will charge you a fee for administering your account and pass along investment expenses.
- When applying for financial aid, the plan is generally considered parent’s/grandparent’s asset.
- Funds in a college savings plan can be used for graduate school.
- Qualified expenses are not restricted to tuition and fees- room and board are included.
- Choice of schools does not affect investment return.
- These plans are not state guaranteed.
- Allows you to purchase tuition now for use in the future. There are two ways to do this, through a contract plan or a unit plan:
- A contract plan promises to cover a predetermined amount of tuition expenses in the future, in exchange for a lump sum or periodic contributions.
- With a unit plan, you purchase a certain percentage of units or credits and the plan guarantees that whatever the percentage of college costs such units cover now, the same percentage will be covered in the future.
- Prepaid plans typically charge a flat enrollment fee and usually there not any ongoing charges.
- When applying for financial aid, the plan is generally considered the parent’s/grandparent’s asset.
- Specified enrollment (limited).
- May be limited to undergraduate school.
- Generally restricted to tuition and mandatory fees (not room and board).
- May restrict out-of-state costs and if less than in-state costs, will not return the difference.
Gifting To A 529 Plan
Normally, an individual can give another individual only $14,000 a year without incurring gift taxes. However, under Internal Revenue Code Section 529, an individual can gift up to 5 years of the annual $14,000 exemptions at once when contributing a child’s post-secondary education. This is a great bonus for anyone who wants to gift in a lump sum.
How To Find The Right Plan
Another bonus associated with 529 plans is that you aren’t restricted to the using the plan in the state in which you reside. You will want to look for a plan that meets your objectives and goals and do your due diligence on the plan itself and the fund managers. Here is a great 529 plan locator.
Are you concerned about how you are going to foot the huge college bills down the road? Don't put off until tomorrow what you can do today and start investing in a 529 plan.