For most people, the two biggest life events they need to save for are college educations for their children and funds for their own retirement.
Let’s spend a few moments talking about saving for college.
Perhaps your potential Harvard graduate is still in diapers. But, given the high cost of college, you’d be smart to start a systematic college savings plan now.
One of the options available for saving for college is a 529 plan. Because this savings vehicle offers the advantage of tax-deferred growth, it should be the cornerstone of any college savings program.
So what is a 529 plan? A 529 plan is a savings vehicle that is governed by the federal government but offered by states. Anyone can open a 529 plan. There are actually two types of 529 plans: college savings plans and prepaid tuition plans.
A college savings plan, which is the more popular type, is an individual investment account to which you contribute money. Your money is allocated to your choice of one of the plan’s pre-established investment portfolios, which generally range from conservative to aggressive in their amount of risk. Returns aren’t guaranteed, but funds can be used at any accredited college. Almost every state offers a 529 college savings plan, and you can join any state’s plan.
The second type of 529 plan is a prepaid tuition plan. As its name suggests, when you join this type of plan you actually prepay your child’s college tuition at today’s prices. The contribution you make today is generally guaranteed to cover a certain percentage of college tuition tomorrow. However, you are typically limited to your own state’s prepaid tuition plan, and your child is limited to the colleges that participate in the plan—generally in-state public colleges.
The main benefit of a 529 plan is that your contributions grow tax deferred and earnings are completely tax free at the federal level when they are withdrawn to pay the beneficiary’s qualified education expenses.
Note, however, that withdrawals that aren’t used for qualified expenses are subject to federal income tax as well as a 10% penalty tax. Additionally, there are fees and expenses associated with both types of 529 plans.
Finally, it’s important to note that, if you’re considering a 529 plan, it generally makes sense to start by checking to see if there’s a plan offered by your state, since that plan might provide favorable state tax benefits to residents. And you should always read the issuer’s official statement carefully, and consider the investment objectives, risks, charges, and expenses associated with a 529 plan before investing.
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