My wife and I are expecting our first child in a few months and as part of our preparation for parenthood, the topic of college tuition has come up. With college tuition rising faster than inflation, we know that saving for college is important!
My wife and I have started saving for our retirement and we have eliminated all debt except our mortgage, so we decided we should start planning for our children’s education costs. We have done a bit of research over the last few days so I want to share what I learned about 529 College Savings Plans and Coverdell Educational Savings Accounts (ESAs). I will start with the 529 plan and continue this mini-series by adding articles throughout the week.
What is a 529 plan?
A 529 College Savings Plan is a tax advantaged college investment and savings vehicle designed to encourage parents and other family members to save money to help pay future college expenses. Like a 401K plan, the 529 plan gets its name from the section of the Internal Revenue Code that spells out the rules for its tax advantages, deferrals, and other information.
How does a 529 College Savings Plan work? The 529 plan owner makes contributions to the account and can assign a beneficiary to receive the money once they reach college age. The plan and money stay in the owner’s name until the money is withdrawn by the beneficiary for educational expenses.
529 College Savings Plan transferability. The assets held in your 529 plan can be transferred without penalties to another family member to use for their education. This means my wife and I can open accounts under our name and change the beneficiary to our child after he or she is born. We could also elect to use the 529 College Savings Plan for our own educational costs should we wish to.
Contributions and withdrawals. Contributions are made with after tax dollars, like with a Roth IRA. However, there may be certain tax benefits for 529 plans depending on which state you live in and in which plan you participate. Withdrawals from a 529 College Savings Plan is similar to a Roth IRA – the money that is withdrawn is tax free if it is used for qualified higher education expenses. Qualified expenses generally include tuition, room, board, books, lab fees, and computers. Be sure to check your 529 plan for more details.
Types of 529 College Savings Plans: prepaid and savings.
Prepaid Plan. Some states offer prepaid tuition plans that allow parents to lock in tuition at current rates for any state college. The benefit is that you can start making fixed payments now to pay off college at today’s rates. By spreading it out over time, it is much more affordable. The disadvantage is that if your child goes to an out of state or private university, you may only receive a portion of the benefits you paid into.
Savings Plan. The 529 College Savings Plan is more flexible than the prepaid version. You control the money you deposit into your 529 Savings Plan and invest it in a portfolio of your choice. Depending on the state plan you join, you can invest in mutual funds, annuities, CDs, and more. There are two main advantages of the 529 College Savings Plan. The first is that the savings can be used for tuition and expenses at any public or private college in the US, not just the state of residence where tuition was prepaid. The second advantage is you control where the money is invested, which may make it easier for you to grow your money above the rate of inflation.
529 plans offer flexibility and tax advantages
The 529 College Savings Plans is a great way to start saving for college. There are certain tax advantages to 529 plans which will be covered in a later article and the option to transfer the money to another beneficiary is an added benefit. 529 Savings Plans are also widely available: each state offers a 529 plan, but you are free to choose which plan you wish to open. If you are saving for your children’s education, I encourage you to do more research into 529 College Savings Plans.
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