529 College Savings Plans
With all the publicity over the rising costs of higher education and the tools available to actually project the costs of an education at a particular public or private school for a specific term, smart parents are thinking ahead to the day when their little ones will be heading off to college.
Although there are several tax and education credits for people of all ages, a 529 College Savings Plan can be an effective education strategy to set aside funds for your kids’ future educations. Section 529 (of the Internal Revenue Code) established this education tax savings plan to be operated by a state or educational institution to help families prepare for future college costs.
Earnings in 529 plans are not subject to federal income tax or state income tax, provided withdrawals are used for eligible college expenses, such as tuition and room and board. Beware though when considering a 529 plan as a vehicle for saving for your child’s future educational expenses.
If you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings. Many states offer tax credits and other education programs (such as matching grants for investing in a 529 plan) but you may only be eligible for these education tax benefits if you participate in a 529 plan sponsored by your state of residence. Just a few states allow residents to deduct contributions to any 529 plan from state income tax returns.
There are two types of 529 plans, College Savings Plans and Pre-Paid Tuition Plans:
‘ College Savings Plans are similar to 401(k)s or IRAs because contributions are invested in mutual funds or similar investments. This education tax plan typically will offer several investment options from which to choose. The account may fluctuate in value based on the performance of the particular option the account owner selects.
‘ Pre-Paid Tuition Plans permit the pre-payment of all or part of the costs of an in-state public college education. These plans are ideal for parents/grandparents or other relatives who currently have the cash available to fund a child’s education but are concerned about inflation’s future effect on college tuition. Most 529 plans may be converted for use at private and out-of-state colleges. The Independent 529 Plan is a separate prepaid plan for private colleges.
All fifty states and the District of Columbia sponsor at least some type of 529 college savings plan or other education tax help. In addition, some private colleges and universities sponsor a pre-paid tuition plan. Similar to the requirements for tax and education credits, funds from 529 College Savings Plans may be used at eligible institutions of higher learning. Note that if the school is listed on the FAFSA (Free Application for Federal Student Aid) website, it is eligible for a 529 college savings plan.