What Are 529 College Savings Plans and When Should You Start Considering One?
by Sandy John
With college costs growing at about 3 percent a year, it’s common–and reasonable–to worry about how to pay for your kid’s education. A 529 college savings plan is a simple way to save for college. These plans are designed to encourage families to save for college expenses by allowing your investment to grow tax-free. Officially, these plans are known as “qualified tuition plans,” and the 529 refers to the section of the IRS Code that covers them.
On your own, you could invest money for college in any way you want–cryptocurrency, fine art, real estate, or Apple stock. But a 529 account offers a wealth of benefits and far less risk than you get with those other benefits. Here are some of the perks that come with a 529 plan:
Every state in the union sponsors a 529 plan, typically managed by one of the large investment firms like Vanguard or TIAA-CREF. Parents or grandparents can open an account and name the beneficiary – the child whose education you’re investing for. You can choose from a range of mutual funds and other investment options, and you can change your investment mix later if you want to. Some plans offer age-based portfolios where the investments get more conservative as the beneficiary nears college age. That way, your college savings are less at risk if the market drops just as you need the money.
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You’re free to shop around and set up an account with any state you want to. You might find some states offer more investment options, a particular investment that appeals to you, or lower fees. However, be sure to check the plan in the state where you reside. Depending on where you live, your state might offer incentives to residents who invest in the state 529 plan, such as:
You can usually open a 529 savings account online by filling out a simple form with basic info including the Social Security numbers of both you and the account beneficiary. These are known as direct-sold plans, because the accounts are sold directly to you.
You can also work with a professional financial advisor to buy an advisor-sold plan. Returns from these plans are sometimes higher than on direct-sold plans, but the fees may be higher, too.
While states sponsor the plans, being in a state’s 529 program doesn’t give your student any advantage in being selected for a specific college or university. It also doesn’t stop students from applying to any school in any state they want and using their 529 savings to pay for tuition there.
These plans are designated specifically for education savings. If you withdraw money from a 529 plan and use it for anything that isn’t a qualified education expense, you’ll be responsible for federal and state income taxes plus a 10% federal tax penalty on the earnings.
The amount of money in a parent’s 529 account will be factored into the calculations when a student is considered for need-based financial aid, although 529 accounts are a far smaller factor than parent income and other assets.
Remember, a 529 isn’t the only way to save for your kids. UTMAs and savings plans have their own advantages and you should think carefully about how much you want to stash away before committing your money to this type of college savings account.
As with any investment, the sooner you start saving, the longer your money has to grow. If you put $100 in a 529 account every month for 18 years and earn 5% annually, your account should have about $35,000 by the time your child is ready for freshman orientation.
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