There seems to be a lot of confusion regarding 529 plans, the program for college savings. As a result many families don’t take advantage of them. Yet 529 plans are a great way to save for college. They are widely available, provide tax advantages and are more flexible than you may think.
There are 108 unique 529 plans available across the country. At the end of 2016, there was more than $275 billion invested in them. Yet many families aren’t taking advantage of the benefits this savings option offers. Only about 2.5 percent of families owned 529 accounts at the end of 2013, according to the Federal Reserve.
A 529 plan is a tax advantaged way to save for college. Regardless of whether your state offers one, you can save for college in a 529 plan, and all the earnings on your investments accumulate tax free. Qualified distributions are also tax free. The tax savings on the earnings alone are worth a lot.
Suppose you save $100 per month starting when your child is born until she goes off to college. If your account earns 6.0 percent per year and your combined state and federal income tax rate is 35.0 percent, saving in a 529 plan will allow it to grow by an extra $7,400 relative to a regular taxable savings account earning the same. If your state does offer a plan, they also may offer tax incentives to contribute to it. Contributions may qualify to be deducted from your income for state tax purposes, making saving for college a little easier.
Anyone can invest in any state’s 529 college savings plan. You can find an annual ranking of 529 plans online from Morningstar. SavingforCollege.com also offers a ranking, though they use different criteria. If your state offers a plan, the tax benefits on the contributions may make it worthwhile to invest in your own state’s plan, even if it isn’t top rated.
Worried that the money saved in a 529 plan is only eligible to be used at the public universities in your state? While there are plans that allow you to save specifically for your state’s schools, called prepaid tuition plans, there are only 20 of them across the country.
The vast majority of plans will allow you to withdraw the money tax free to pay for expenses at virtually all accredited public, nonprofit, and for profit post secondary institutions any where in the country. It doesn’t matter if the school is a college, university or vocational school. Here in Oregon, 529 plan savings from any plan can be used for everything from the University of Oregon and Oregon State to Le Cordon Bleu College of Culinary Arts and a wide variety of programs in between.
What if your child doesn’t wind up going beyond their high school education? First you never know what your child will do in the future. There are no limits to how long money can stay in a 529 plan, as long as the beneficiary is living. If your child doesn’t go to school right away, they may down the line. If that doesn’t happen, the beneficiary of the account can be changed to anyone in your family out to first cousins of the original beneficiary. That means the money could be used for your own education, your siblings or their children’s education. Even your parent’s can use it if they have a desire to go back to school.
If there is absolutely no one in the family that can take advantage of the money, it is still yours. It can be withdrawn at any time. Withdrawals that are not made for qualified educational expenses will be taxed with an additional ten percent penalty. This is what get’s people concerned about saving in a 529 plan. But it’s not as bad as it sounds.
In the example above, total earnings on the account are $15,500. This is the amount on which the taxes owed will be calculated. Assuming the same 35.0 percent combined tax rate, the taxes due would be $5,425 plus an additional penalty of $1,550, or total taxes of $6,975. You would also have to repay any state tax benefits you received on the contributions.
This is not the end of the world. You get all of your contributions back, and the taxes you wind up paying are still less than the additional benefit you gained by growing your savings tax free ($7,400). Paying back the state tax deductions on the contributions will cost a bit more, but you will still have more money than you contributed to the plan in the end.
529 plans are a great way to save for college. If you have doubts, make sure you get the facts before you give up on this tax advantaged savings option. For more information regarding 529 plans, check out the SavingforCollege.com web site, or visit the site for your own state’s plan. 529 college savings plans can help you make more out of your college savings dollars, and they are more flexible than you may think.
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