A college degree is often seen as a stepping stone to a better career. Yet, the costs of that degree are often growing at an unbelievable rate. A 529 plan can be a great way to save for college
Types of 529 Plans
The first type of 529 is an investment account. You add money to your account and invest it in a variety of different mutual funds. All 50 states offer these 529 plans, and they are often more flexible because you can use the money for most qualified college expenses including tuition, room and board and textbooks.
Prepaid tuition plans
The second option is a prepaid tuition 529 plan. With these plans, you prepay for semesters of college tuition at today's rates. This locks in the price so you don't have to worry about college tuition going up in the future. These plans are more restrictive and not all states offer them. You need to be aware that these types of 529 plans only lock in the tuition at schools listed on the plan. If your child attends a school that isn't on the list, you'll be able to transfer over the value of your account, but there's no guarantee that it will be enough to cover the full cost of tuition. Also, the prepaid plan in your area may not be able to be used for expenses beyond tuition, such as textbooks or room and board. Be sure to investigate plans in your area thoroughly if this is an option you're considering.
The 529 plan comes with some nice tax benefits to help you reach your savings goal. As long as you keep your money invested in the 529 plan, you won't have to pay taxes on your investment gains. When you withdraw money from a 529 plan for college expenses, your withdrawal will be tax-free. This means you don't have to pay any sort of taxes on your investment earnings when making qualified withdrawals. Finally, some states will give you a tax deduction for your contributions to a 529 plan in that state. There is no federal tax deduction available.
There are no income restrictions on the 529 plan. So no matter how much you make, you can leverage the plan's benefits. Maximum contribution limits are typically very high. So by the time you max out the 529, you should have enough to handle the majority of most college expenses.
Putting money aside early for college is a nice idea, but can make some people nervous. After all, what if your child decides not to go to school, did you waste all this money? The short answer is “no.”
A 529 plan keeps you in control of the money. If your child decides not to go to college, he or she won't have access to the money unless you want them to. You can transfer the plan to help pay for someone else's education, or withdraw the money to be used for other expenses. However, if you don't use the money for education expenses, the IRS will charge income tax plus a 10 percent penalty on your investment earnings. While that's not always great for your investment, it does provide a little peace of mind in knowing that you can access the money if your plans change.
NOTE: As of 2018, the IRS has amended the term “qualified higher education expense” to include a limited amount of annual expenses from a 529 Plan for tuition at an elementary or secondary public, private, or religious school. Source: https://www.irs.gov/newsroom/529-plans-questions-and-answers