529 Plans: A Tax Advantaged Way to Save for College

saving for college costsSaving for college tuition is difficult to do and when it is being juggled with the cash flow and other priorities inherent in running a small business, time can sometimes get away from small business owners who are also parents.

But college tuition costs are rising at twice the rate of inflation & it doesn’t look like that will slow down any time soon, so it’s important to get started sooner rather than later. A 529 Plan is one option to consider.

529 Plan Basics

One popular way to save for college is to contribute to a 529 Plan. Earnings in the plans are not subject to federal or, in most cases, state income tax, thus the earnings grow in a tax advantaged way. These tax advantaged savings plans are part of the federal Qualified Tuition Program.

There are two types of 529 Plans: Prepaid Tuition Plans or College Savings Plans. Plan proceeds may be used for undergraduate or graduate level education expenses, including tuition and fees. Some plans also cover other expenses such as room and board, fees, computers and books.

Friends and families can also contribute to your child’s 529 Plan, so consider that when someone asks what gift to give for a birthday or other celebration.

Prepaid Tuition Plans

These plans essentially purchase units or credits at specific universities or colleges. Generally, they:

  • cover tuition & mandatory fees (room and board options are sometimes available)
  • lock in tuition prices at specific eligible colleges and universities
  • are sponsored by state governments
  • can have residency requirements
  • often have state based investment guarantees
  • are managed by the sponsoring government so there are no individual investment choices or decisions
  • have limited enrollment periods plus age/grade limitations

College Savings Plans

These plans can be used to save for a wider variety of education related expenses, but don’t lock anything in. They:

  • cover “qualified higher education expenses” including:don’t usually have residency requirements
    • tuition & mandatory fees
    • room and board
    • books
    • computers
  • are sometimes sold through financial brokers
  • are subject to market based investment risk
  • have a variety of investment options, such as bond & stock mutual funds
  • can usually be used at any college or university

Watch Out for Fees

The tax advantages can be useful, but fees on the investment vehicles offered can be high. When deciding if this is the right college savings approach for your family, it’s important to compare different 529 Plan options before deciding. You will want to ask carefully about any up front and long term account fees, especially on plans sold by financial institutions. Fees and expenses vary based on the plan, but they can significantly affect your total earnings on your savings, and thus the amount of money available for your child’s education.

Questions to Ask

There are other options for college savings, so don’t sign on the dotted line until you are sure that a 529 Plan meets your needs. Some basic questions to ask are:

  • What are the withdrawal fees or penalties, if any?
  • What happens to the money if my child doesn’t go to college?
  • What colleges or universities are eligible for the plan & can that change?
  • What are the annual fees?
  • Are there residency requirements?
  • What are the investment fees and sales charges?
  • Is my savings guaranteed?
  • What are the restrictions on school choice?
  • Are there any investment guarantees?
  • What types of investment options are there & how often can I switch between investment options?
  • What types of college or university expenses are covered?
  • Is the plan offered directly by the plan sponsor (state or agency) or must it be purchased through a financial advisor or broker?

How much do You Need to Save?

There’s a handy college savings calculator on the FINRA website that will help you to estimate your savings needs and goals. One thing to keep in mind when estimating is that different college majors tend to have different out of pocket costs and geographic locations can greatly impact a student’s out of pocket living expenses.

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