As a parent, you may be concerned about how to pay for your child’s college, even from the day they are born. Reviewing the myriad choices available for savings plans can be daunting. After all some of the plans have unusual names. For example, what is a 529 plan and how can it help you help your child?
Saving for the Future
When you need to save for a child’s future educational costs, a 529 plan might work. This tax-advantaged savings plan is designed for just that. Internal Revenue Service Code Section 529 provides the foundation and the name for this financial account. However, plans are typically sponsored by states, state-run agencies, or educational institutions.
Two Types of 529 Plan
There are two basic types of 529 plan:
- Pre-paid tuition plans allow the account holder to buy credits for future tuition and fees at current prices. So, you can pay for some of Junior’s college now instead of waiting for the inevitable price increase. There are limitations, however. For example, prepaid tuition plans generally cannot be used for future room and board at colleges and universities. Other limitations apply, including residency requirements and limited guarantees.
- Education savings plans provide a way for parents (or other donors) to open investment accounts to pay qualified education expenses for a future student. Tuition, fees, and room and board can be paid with savings plan funds. Withdrawals are not limited to state-run colleges. In addition, money from this plan may be used for public, private, or religious elementary and high schools.
Fees, Expenses, and Returns
Savings plans typically offer some kind of ‘return’ or interest. However, it’s important to remember that fees and expenses paid to open and maintain a 529 plan generally lower the return. Expenses and fees vary from plan to plan, so read the fine print for signing up:
- Prepaid plans generally charge accountholders an application fee and some type of administration fee.
- Education savings plans, like 529s, may charge a few more fees, including some for annual account maintenance, program management, or asset management.
And Taxes, Too
As with expenses and fees, taxes vary also. In some states, contributors may claim a tax deduction for their contributions. However, you may be limited to 529 plans sponsored by your home state.
As for withdrawals, someone who uses the money for qualified education expenses or qualified tuition typically is not charged any federal income tax. However, if the money is used for other unqualified purchases, taxes and penalties may apply.
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