Parents who are in the unenviable position of saving for their retirement and their child’s education must start early to ensure their financial goals are met.
The controversial topic of which is more important retirement or college savings becomes less of an issue with proper planning well in advance.
State sponsored 529 plans have been around since 1996 but have been gaining popularity in the last few years with parents who choose to pay for all or some of their child’s education. The following information explains the benefits and risks associated with these accounts.
What Are 529 Plans?
To put it simply a 529 plan is an investment account that offers tax advantages which make it very appealing as a way to save for college education.
Each state offers a 529 plan and you also can choose between a prepaid plan or a savings plan. If you want flexibility in your plan you may opt for the savings plan which is generally offers less growth but can be used at any institution.
The prepaid plan on the other hand is used to pay for tuition at today’s rate at a specific institution. If you use your states 529 plan you may be eligible for state tax deductions. Interest earned in the account (when used for college expenses) is exempt from federal and possibly state taxes.
Benefits Of Using A 529 Plan
This method of saving for college expenses offers benefits beyond tax breaks and deductions such as:
- Parents retain control of the fund. This is important if you worry that your child may grow up and decide to use their college savings for a trip abroad or a new car. You have control over the account and make the decisions when and how the money will be used.
- Until you decide to withdrawal the money you will not have to worry about reporting information on your tax return. The year the money is taken out of the account will be the only time you receive a 1099 form to report taxable or nontaxable earnings.
- These plans offer flexibility in that you can move your investment to another 529 savings plan or change the beneficiary in the event your child does not go to college or receives scholarships which cover the expenses.
- Most 529 plans allow for substantial deposits which are not just limited to the parent. Grandparents, aunts and other individuals can contribute to your child’s education over the years. In most cases there are no age restrictions or income limitations for these plans.
- Plans owned by a parent or other donor will not have a significant impact on your child’s ability to receive federal financial aid as is considered a “parental” asset.
Risks and Drawbacks
As you can see using a 529 plan can be an excellent way to put money back toward ever growing college expenses however they are not without certain risks or penalties.
- Withdrawing money for anything other than college expenses will result in the owner of the account having to pay income tax on the earnings as well as a 10% penalty. If you have received a state tax deduction you may have to repay that as well.
- Some colleges take into consideration family owned 529 plans when determining scholarship or grant recipients.
- Certain savings plans have high administrative fees which can reduce your earnings. For this reason it is very important to carefully review all information before committing to a specific plan. Do your research, shop around and compare plans carefully to find the best option for your family.
Saving for future expenses, whether they are expected or unexpected is necessary in every household. For families with children going to college, using a 529 plan can make preparing for the high cost of education makes paying those expenses less of a drain on the household budget.
This is a guest post by DebtKid, who blogs about his debt management journey.