If you’re starting to save for your child’s college education, you may be uncertain about the options available to you. Are you planning on using a traditional savings account? Savings bonds? How about a 529 savings plan? Many new parents are unfamiliar with the 529 plan, but it can be a great way to save for your child’s future.
• What is a 529 savings plan?
A 529 savings plan is an investment that is specifically earmarked for the payment of education expenses. These plans are either run by the state or by a university. Those that are run by a specific university are intended to be plans to be used for your child to attend that university; in other words, you are deciding which university your child will attend before you even start saving for their education. 529 plans that are for specific universities are typically referred to as “prepaid plans”. Additionally, every state operates a 529 plan program, which can be used to pay for any eligible educational institution.
• What are the advantages to using a 529 savings plan?
Like 401(k) retirement plans, there are tax incentives to putting money aside in a 529 plan. While you will be taxed regularly on the portion of your income that goes into the plan, there is no federal taxation on money that is taken out of the plan to pay for college costs. State tax benefits vary by state, but there are those that offer the same kind of incentives as the federal taxation on 529 plans.
These plans are also beneficial because, once you fill out the initial paperwork, the maintenance of the plan is very hands-off. The money you are setting aside for your child’s education will continue to earn interest, and you will not have to continuously manage the investment.
If you are concerned about your child having access to the funds and using the money for unqualified expenses, you do not need to worry. The money in the 529 savings can only be taken out by you; your child is not eligible to withdrawal funds for the account.
• Are there any disadvantages associated with using a 529 plan?
The biggest disadvantage to a 529 plan is that there are many lucrative investments available in the market that cannot be accessed with a 529 plan, limiting the potential interest earnings on such a plan.
Another reason that you may want to explore other options is because funds in the 529 plan can only be used for approved college expenses. If used for other purposes, money withdrawn from the account is subject to a federal tax of 10%.