Another topic we’re going to focus on this month is saving for college. Whether you’re a financial professional or not, you should certainly know that saving can go a long way in easing the burden of education costs.
Today, I’m going to discuss the 529 savings plan which was created to encourage families to save for education costs in the future. The “529” refers to Section 529 of the Internal Revenue Code, which describes certain “qualified tuition programs”. The qualified programs must be under the direct, or indirect, auspices of a government agency or authorized educational institutions.
There are two types of programs outlined in Section 529: prepaid tuition plans and education savings plans.
Prepaid Plan
Under the prepaid plan, an individual can buy tuition credits on behalf of a beneficiary (e.g., their child, themselves, or anyone else) at current rates to be used in the future. Generally, these plans can’t be used to pay for room and board. Also, many of these plans are offered through state governments and include residency requirements.
Prepaid plans aren’t guaranteed by the federal government, and whether a plan is or not depends on the state. If your plan isn’t guaranteed, it’s possible you could lose all your money. Also, if your child decides to attend a nonparticipating school, the payments could be much less than if they attended a participating school.
Education Savings Plan
If you elect to use the education savings plan, the idea is to open an investment account with the intention of using the funds to pay for education expenses in the future. Qualified expenses include tuition, fees, and room and board—so, unlike many of the prepaid plans, the earnings from this plan can be used to pay for a place to live during school. Funds from the education savings plan can be used at any college or university, and even some foreign schools. What’s more, these plans can also be used to pay up to $10,000 a year for tuition at any elementary or secondary school.
The investment account under the education savings plan can include a range of investment portfolio options, frequently involving mutual funds, exchange traded funds (ETFs), and a principal-protected bank product.
You can also choose between static fund portfolios and age-based portfolios. Static portfolios follow the same asset plan unless the owner decides to reallocate. Age-based portfolios, however, typically have a more risky, aggressive approach when the beneficiary is younger and gradually shifts to a more risk-averse approach as they get older.
Unlike the prepaid plans, the education savings plans usually don’t have residency requirements. Also, education savings plans are not guaranteed by state governments, however some principal-protected bank products may be insured by the FDIC. Like all investments, there is risk that goes along with education savings plans and you could lose some of or all your money.
Each type of plan includes fees to participate, so it’s important to research each plan to figure what works best for you.
Tax Benefit
One of the incentives to a 529 savings plan is the tax benefit. Many states may deduct plan-contributions from state income tax or matching grants. Also, if you use 529 plan withdrawals for qualified expenses, your earnings won’t be subject to federal income tax or, if applicable, state income tax. However, if your withdrawals are used for non-qualified expenses, you will have to pay regular income tax plus a 10% federal tax penalty.
You can learn more about what 529 plan works best for you at the College Savings Plans Network website.
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Investors should consider the investment objectives, risks, and charges and expenses associated with the 529 plans before investing. More information regarding 529 plans is available to the issuer’s official statement. Please read the official statement carefully before investing. Investors should also consider, before investing, whether their home state or the home state of the beneficiary offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program.
Other states may include financial aid, scholarship funds, and protection from creditors.
As with any investment in a mutual fund or other equity security, an investment in a 529 savings plan can decrease in value.
Neither NEXT Financial Group, Inc. nor its Representatives give tax or legal advice.
https://www.law.cornell.edu/uscode/text/26/529
