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529 plans are educational investment accounts with special rules and tax benefits that help families save for college – and even for K-12 tuition. These plans come in several forms: a prepaid curriculum or a savings plan that allows after-tax contributions to investments in mutual and exchange-traded funds.
A 529 plan can be a smart way for you to start saving up early for your child's college education.
Plans are available in all 50 states, with plan managers tasked with selecting investments that they believe are best suited to that state's plan. This potentially leads to a simpler investment process and lower fees negotiated based on group buy-ins.
Although every state offers a plan, they are not all created equal. The best 529 plans have the lowest fees and offer a better range of investment options.
Read on to learn more about saving for college, plus the pros and cons of 529 plans.
What is a 529 plan?
A 529 plan – named after the section in the Internal Revenue Code that approves qualified curricula – is an educational investment account with rules and guidelines established by individual states. Each state negotiates its management and mutual fund fees separately, similar to how 401 (k) plan fees are negotiated for corporations.
These educational savings accounts were originally designed for college savings only. Now they can also be used for some K-12 cost in certain states. You can now earn up to $ 10,000 annually in tax-free withdrawals to pay for expenses in public, private, or religious elementary and secondary schools.
529 Plan Benefits: 8 Ways To Save For College
Because they are so common, you should be able to compare many college savings plans. That way, you can find the one that has the options that best suit your needs. 529 plans offer several benefits, including:
- Federal tax breaks. You don't pay any tax on 529 plan revenue, provided you use the money to pay for qualified higher education, vocational school, K-12 tuition, or tuition fees or expenses. Qualifying costs for higher education include tuition, room and board (provided you are at least half enrolled), books, and computers or computer equipment for the student.
- State tax breaks. States can offer tax benefits such as tax credits or a tax deduction for contributions to 529 plans. Tax deductions are often limited per beneficiary and per taxpayer. For example, Utah couples filing together can contribute up to $ 4,080 per year per beneficiary to my state's plan, my529, and receive a 5% tax credit. So a contribution of $ 4,080 translates into tax savings of $ 204.
- Age-based options. You don't need to be an investment expert to develop a successful 529 plan savings strategy. You can choose an investment package based on the age of the student and your family's risk aversion. Families worried about losing money on their investment are likely to choose a more conservative plan that offers less exposure to the stock market.
- No income related restrictions. Certain tax breaks for education – such as B. Public Education Tax Credits – set a maximum income limit to qualify, which means not all families can benefit. 529 plans do not impose such restrictions. You can qualify for federal tax breaks on 529 items of income regardless of your income.
- Prepaid Tuition Fees. About a dozen states offer guaranteed curricula that can save you on future tuition fees at today's prices. This way you can avoid price hikes and tuition fee inflation. You can compare plans by state to see if your home state offers a prepaid study plan.
- Flexibility of use. 529 Plan funds can be used for qualified apprenticeship programs, business schools and some continuing education institutions. Parents can even use leftover 529 plan funds to take classes, advance their own careers, or repay up to $ 10,000 in student loan debt.
- A number of ways. You can choose a plan from any state, but make sure you do your homework as some plans are better than others. All you need to do is check the website of your state's Department of Taxation to see if plans from other states are still eligible for income tax deduction.
- The ability to change investments. The federal tax law allows the account holder to change investments twice a year or when the beneficiary changes. That said, if you don't like the performance of your plan, don't stick with your original choices. "Review your investments in your 529 plan account quarterly to make sure you are investing in the right mix of options," said Mary Anne Busse, 529 plan expert and general manager at Great Disclosure, a Royal Oak consultancy , Michigan.
"Many people find themselves in individual investment options that may be too aggressive when their student is about to graduate," says Busse. If you're unsure of how to invest, 529 plan websites have tips on what type of investor you are, she says. You can also call the plan's customer service department for help in choosing the best investment package for you.
529 cons plan
As with any investment, there is a risk of using a 529 plan to save up for college. There are pitfalls to look out for when investing in a college savings plan, including:
- Tax penalties for certain withdrawals. Do your best to make sure you can afford your contributions as part of your household budget so that you don't have to withdraw the money you have deposited. While your withdrawals for qualified education expenses are tax-free, non-qualified withdrawals are subject to federal and state income taxes, as well as a 10% federal income tax on income.
- Limits to investment flexibility. While you have a number of options with 529 plan investments, you must make a selection within the offerings of this plan. Investors looking to get more exposure may want to choose plans or other types of investment accounts with more options.
- Runs out of money before college. Money spent on K-12 spending doesn't have much time to grow from the income. Thus, more money comes out of the pockets of the account holder and the contributors. It also limits the amount available when it is time for students to enter college.
Bottom line
With 529 plans, you can target savings for a variety of academic needs while enjoying state and federal tax breaks for plan owners and contributors. College savings plans are pretty easy to set up. You should always check the 529 plan tax break rules to make sure you are choosing a qualifying plan. When it's time to withdraw, check to see what qualifies as a qualified educational effort.