What is a 529 College Savings Plan?

Education is one of the greatest tools a person can use to get a jump start on their career.  By getting a good education they can bypass years of on the job experience.  Unfortunately, education costs are often expensive.  Thankfully there are ways for parents and grandparents to save up for their loved one’s education.  The 529 plan offers some great tax benefits, but it also has a few drawbacks.  Whether or not one should be used depends a lot on the individual situation.

There are two basic types of 529 plans.  There is a pre-paid tuition plan, which is rarely used, and there is the more common college savings plan.  Both allow a person to set aside money for education costs, and both provide excellent tax benefits.  After a person has decided to use a 529 plan, they must then decide if they want to use a state plan, or an out of state plan (note: this is not for an out of state college, however, it is a plan sponsored by a state other than that where the account owner lives).

Money that goes into these college savings plans is deposited after tax has been paid.  Once in the plan the accumulations grow tax deferred.  As long as the money is spent on qualified higher education expenses, including tuition, room and board, books, and other college necessities, the money will not be taxed federally.  However, if the money is used otherwise, the government will often impose a 10% penalty as well as regular income tax.   State plans will often get a break on state taxes as well, for those investing in an out of state plan, they most likely will not see these state tax breaks.

One of the biggest drawbacks of the 529 plan is the uncertainty that comes with it.  If the child is gifted and earns scholarships, they may not need to use the money for education expenses.  On the other hand, if they choose not to go to college, they will not need the money either.  A state plan is enticing because of the tax benefits, but often the plans do not offer the investment options the individual would like.  Finally, the accumulated savings might actually affect the student’s ability to get financial aid.  With so many variables, the individual should carefully consider whether or not the plan is right for them.

When making the decision to open a 529 plan, you should keep in mind that you control the funds, not the child.  At any point you can change the beneficiary of the account, so if the first child does not use the money it can be switched over to another child.  Unlike when planning for retirement there is no limit on how much can go into a 529 college savings plan.  So for most, the contributor can do as little as $50 per month or as much as a lump sum in the 6 figures.  The bottom line is that it is best to get some basic information, and then talk with a trusted advisor if this is the right account to open for your loved ones.

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