No matter the age of your child, a 529 plan is a good option for saving for college.
A 529 college savings plan, also known as a “qualified tuition plan,” allows you to set aside money for college costs, investing the money in funds that grow tax-deferred. No tax is owed on the proceeds when you use the money to pay for college costs.
These plans were first authorized in 1996 by the Internal Revenue Service through Section 529. They are sponsored by states which partner with a financial services firm to provide that funds. Some educational institutions have their own prepaid plans as well.
The 529 plan in each state is different. Just because you have a plan affiliated with a specific state, the funds can go to pay tuition in any state. You don’t need to choose the plan your state offers.
The savings portion of the 529 plan is an investment plan, much like a 401k or individual retirement account (IRA). The value will fluctuate based on the investment returns of the underlying funds in the plan. The earnings aren’t subjected to taxes as long as the withdrawals are used for expenses such as tuition, room and board and even books. The contributions to the plan are not deductible for federal taxes, but in some states are deductible for state taxes.
If withdrawals are not used for educational expenses, the amount is subject to federal income taxes and a 10% penalty. That withdrawal may also be subjected to other taxes, such as state, local or dividends tax. A loan can’t be taken out against a 529 plan.
If you open a basic prepaid plan through a state, you typically don’t have an investment account associated with it. It’s more like an installment plan where you benefit by locking in the tuition rate for an in-state public college years ahead. Plans do allow for conversion to private colleges and colleges in other states. The prepaid tuition plan has to be offered by specific colleges or universities to take advantage of it.
A 529 plan can be established at any time, even if a student is already enrolled in college. The longer the plan is in effect, the more the earnings from your contributions can grow. A 529 plan is set up with a beneficiary, who is the person who will use the plan for educational purposes.
If you think a 529 plan would benefit you, your children or your grandchildren, you can research your state’s options online. You may want to consult a financial planner to help sort through the many options and find the college savings plan that makes the most sense for your family.
