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Saving for a child's college education is one of the largest financial goals people are faced with today, and one cost-effective and tax-efficient tool for reaching that goal is a 529 savings plan. It's not for everyone, but every parent should at least consider using a 529 plan.
What is a 529 plan?A 529 is a tax-advantaged savings plan designed to encourage Americans to save money for college. Every state and the District of Columbia offers some type of 529 plan. Some educational institutions offer them, too. With a 529 plan, you're participating in something like an investment account, through which you can choose from a number of investment options. States also offer prepaid plans, whereby you lock in future tuition costs at current rates through the purchase of tuition credits. But unlike prepaid plans, which are often limited to public universities in the state you live in, the 529 isn't limited to in-state use.
AdvantagesIt's never too early to open a 529 plan account. You can start even before your child is born -- just open the account in your name and then change the beneficiary to your child later on. There are no age or income restrictions for those who enroll, so they're open to practically everyone.
If you use a 529 plan correctly, then you will not have to pay taxes on your earnings or your withdrawals. While contributions aren't tax-deductible at the federal level, some states offer a full or partial deduction. And you won't see any state taxes on earnings in a 529 so long as withdrawals go toward eligible college expenses, which normally include tuition costs, some room and board, and school supplies such as books and laptops.
Regardless of the state you live in, you're free to invest in any state's 529 plan, so you can shop around for plans that best suit your circumstances. Investing in another state's 529 plan won't restrict the school your child can attend, although you may miss out on some tax deductions, so make sure you know what tax benefits that state may offer. Find a local tax professional to help you navigate any possible tax ramifications.
Furthermore, wealthier people who are more tax-sensitive may find the 529 plan's annual gift-tax exclusion appealing. The exclusion allows account owners to gift money to another person without incurring a federal gift tax, so long as the gifting is done on an annual basis. Givers can contribute up to $14,000 per year, and married couples can contribute up to $28,000 per year.
Note that the earnings portion of any withdrawals going toward non-qualified expenses will be taxed as income and can also incur a 10% withdrawal penalty. However, in the case your child receives a scholarship, whether athletic or academic, a withdrawal up to the amount of the scholarship won't be assessed the penalty.
Do your homeworkPlan specifics vary by state and can change frequently. It's important to stay up to date on your state's plan using sources that specialize in 529 plans or college savings. The directory at www.savingsforcollege.com is a great place to find and compare different states' 529 plans. Your state probably has its own website dedicated to its particular plan. And again, in addition to doing your own research, reaching out to an investment advisor or tax professional with more expertise may help bring more clarity to your decision-making process.
Automate your contributionsOne of the best ways to maximize your 529 savings is to figure how much you can afford to contribute every paycheck, month, or quarter, and then have your bank transfer a set amount of money from your bank account to your 529 once every time period. By automating your contributions, you'll remove one more barrier to saving. And as these contributions become one of many fixed expenses, you'll find that you no longer miss that money.
Best of all, automated contributions are a form of dollar-cost averaging, which is one of the easiest ways to lower your investing risk and maximize your returns.
There are other ways to boost your contributions as well. For example, Upromise is a credit card rewards program from Sallie Mae through which cash-back rewards can be applied to a 529 plan. To participate, sign up for a Upromise MasterCard and use it as you would any other credit card for your everyday purchases. Cash rewards accumulate in your Upromise account and can be directed into a 529 plan, as well as some other types of college plans. The money can also be withdrawn as regular cash without penalty.
Bottom lineEven if your state doesn't offer income-tax deductions for 529 plans, using them to save for a child's education might still make sense because the earnings in the plan grow tax-free. As with anything that pertains to investing, you want to keep your options open, and 529 savings plans should at least be on your radar if you're looking to save for a child's college education in a tax-efficient way.
The article Why Every Parent Should Consider This College Savings Plan originally appeared on Fool.com.
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