Continued from a previous post: Introduction to College Savings.
The 529 college savings account is the perfect option if you have excess money to save while your child or grandchild is young and you know for sure they'll be attending college. That's difficult to know in advance, so you're best weighing the pros and cons before you get started. Here's a brief summary of the most important aspects:
- 529 plans are typically managed separately by each state, but that doesn't limit which one you can choose (And Illinois, for example, has 5 different plans!). Some states offer state-tax deductions for your contributions to their plan, and some even extend the tax deduction to contributions made elsewhere. No matter which plan you choose, you can use the savings to pay for college tuition anywhere in the US (and even certain international schools: Check out this long list of eligible international schools). Additionally, if you start a 529 with one particular state, you can roll over the funds to another state's plan later on if needed.
- Distributions from a 529 account are not taxed when used for qualified higher education expenses, including room & board, books, tuition, and computer equipment. You cannot use the funds for elementary school or high school, though, so look at a Coverdell ESA if that's an important component.
- You can still withdraw the funds if your beneficiary or any family member of the beneficiary ultimately don't need all the money you saved. You'll just be subject to taxes and 10% penalty on the earnings, in addition to state taxes for any deductions you previously claimed.
- Each account is typically created with an adult custodian and a child beneficiary. You can open one for anyone, including yourself, and you can also change the beneficiary to another family member of the beneficiary if needed.
- There are two basic types of 529 programs: savings plans and pre-paid tuition plans. The savings plan is generally more flexible option to save in advance and watch your savings grow tax-free. A pre-paid tuition plan, on the other hand, is a more strict contractual arrangement to pre-pay your tuition for an in-state education at a reduced rate.
- Annual contributions are generally flexible for savings plans. There is some complexity when navigating the IRS gifting regulations that limit you to $14,000 per year (or $28,000 from a married couple) to any one beneficiary, but you could still contribute for five years at a time if you had the excess cash to do a larger amount up front. And there's definitely a cap to your state-tax deduction if that's available in your state.
- Some state plans are sold by advisors only and some are direct-to-consumer. Neither is fundamentally good or bad, but it will make a difference depending on how and where your advisor is affiliated.
- Costs are a big deal. There is a wide range when it comes to the costs built into these 529 programs, so be attentive to that when shopping for the best option.
That should be plenty to get you started! Stay tuned for more on college savings in upcoming blog posts.