Saving for college should start sooner rather than later. While many parents plan paying for college expenses immediately after the birth of their child there are many more who only start the process when their child is a senior in high school.
529 College Savings Plans
There are two types of 529 plans—college savings plans and prepaid tuition plans. The college savings version allows earnings to grow tax-deferred and withdrawals are tax-free when used for qualified education expenses. Every state offers at least one of these types of plans. Some states offer both, and a consortium of private colleges also offers a prepaid tuition plan.
With college savings plans, students of all ages can save for all college costs, including tuition, fees, room, board, textbooks and computers.
Not Just for Children
If you are considering going back to college or graduate school, you can open a college savings plan for yourself. You will save on taxes, and if you end up not going to school, you can always transfer the money, tax-free, to another 529 plan for your children or spouse.
Not Limited to In-State Public Colleges or State Residents
Withdrawals from college savings plans can be used at most colleges and universities throughout the country, including graduate schools. Some overseas educational institutions also may be eligible. Many states now offer at least one college savings plan that has no residency restrictions. You can live in Ohio, contribute to a plan in Maine and send your child to college in California. However, if your state offers state tax advantages to residents who participate in the local plan, you’ll miss out if you opt for another state’s 529 plan.
Covered Education Expenses
College savings plans typically cover all “qualified education expenses” at eligible colleges, universities and other post-secondary institutions, including:
- Books and supplies
- Equipment required by school
- Room and board
When you invest in a college savings plan, you pay money into an investment account on behalf of a designated beneficiary. Contributions can vary and are only limited by the maximum and minimum contribution limits set by most plans. Although the maximum contribution amount differs from state to state, in the majority of states offering college savings plans, the maximum amount that you can contribute for one beneficiary exceeds $250,000.
To further increase the amount of contributions you can make, you can open a second college savings plan in another state. Currently, the IRS only requires that contributions for one child cannot be more than the amount necessary for the qualified higher education expenses of that child. So if you want your child to go to an expensive college and graduate school, one option you have is to open more than one college savings plan.
Most states also offer very flexible minimum contribution limits. Many require a $250 initial contribution with subsequent contributions of as little as $50. These minimum contribution amounts can be reduced even further in many states if you make contributions through payroll deductions or automatic transfers from a bank account.
Typically, each plan gives you a number of investment options that allow you to invest in various mutual fund and exchange-traded fund portfolios. Some college savings plans offer age-based fund portfolios. When the child is younger, the portfolio typically invests mostly in stock funds, which carry a higher risk, but higher return potential. As your child grows older, the asset allocation becomes increasingly conservative as it gradually shifts to bond funds and other fixed-income funds.
Many states also offer non-age-based investment options, allowing you to select portfolios with conservative, moderate and aggressive asset allocations. Some states also offer investment options that allow you to invest in certificates of deposits whose interest rates are linked to an index that measures the average cost of college tuition.
Until recently, once you selected an investment option within a college savings plan, you could not change that option. Only new contributions could be invested in different investment options. The IRS now allows you to change your investment options once every calendar year in a college savings plan and when there is a change in designated beneficiary.
Investing in college savings plans does come with some risk. Unlike prepaid tuition plans, they don’t lock in tuition prices. Nor does the state back or guarantee the investments. There also is the risk with most college savings plan investment options that you may lose money, or your investment may not grow enough to pay for college. For example, if you choose a plan option that invests in stock mutual funds, chances are that your invested funds’ annual performance will mirror the trends of the stock market. Thus, you may lose money during a declining market.
Published by FINRA. Fore more Information visit FINRA.org
College Savings Plan Comparison Chart1
|Contributor||Contributor||Contributor||Custodian until child reaches age of majority||Contributor|
|Typically, plans provide several investment options.||None||No restrictions||No restrictions||Savings bonds|
|None||Plan may set age or grade limits.||Except for special needs children, no contributions can be made after a child reaches age 18, and withdrawals must be made before beneficiary reaches age 30.||Minor child||Owner must be at least 24 before the bond’s issue date (not purchase date).|
|Qualified education expenses for post-secondary education||With a few exceptions, only tuition and mandatory fees for post-secondary education are covered.||Qualified elementary and secondary education expenses or qualified higher education expenses||No restrictions on types of expenses||Tuition and mandatory fees for post-secondary education and contributions to 529s and ESAs|
|Varies from plan to plan. Majority of plans permit total contributions in excess of $250,000 per beneficiary.||Fixed by terms of contract you purchase||Contributor: $2,000 per beneficiary per yearBeneficiary: $2,000, does not matter how many ESAs are set up.||No limit||No limit|
|Earnings grow tax-deferred and are tax-free if used for qualified education expenses.||Earnings grow tax-deferred and are tax-free if used for qualified education expenses.||Earnings grow tax-deferred and are tax-free if used for qualified education expenses.||$950 in earnings are tax-free.||Interest grows tax-deferred and is tax-free if used for qualified education expenses.|
|Varies from state to state, but some states provide tax deduction for contributions, tax-free earnings growth and tax-free withdrawals for qualified education expenses.||Varies from state to state, but some states provide tax deduction for contributions, tax-free earnings growth and tax-free withdrawals for qualified education expenses.||None||None||Interest is usually tax-exempt from state and local taxes.|
$95,000 – $110,000Joint filers:
$190,000 – $220,000
$72,850 – $87,850Joint Filers:
$109,250 – $139,250
|Earnings are taxed as ordinary income and may be subject to 10-percent penalty.||Earnings are taxed as ordinary income and may be subject to 10-percent penalty.||Withdrawals that exceed the beneficiary’s education expenses for the year may be taxable.||None||Interest earned is taxed as income.|
Published by FINRA. Fore more Information visit FINRA.org
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