For families trying to save for their children’s college education, 529 college savings plans, named for a section of the tax code, have always been hailed as a great option—perhaps the best. Let’s look more closely at what has always made them a good deal:
- Families invest through these accounts without earnings being taxed as long as the funds are used to pay for college expenses.
- Earnings have been typically free from federal and state taxes.
- You may have a variety of investment choices.
One of the best aspects of 529 plans is that it’s not limited to parents: grandparents, aunts, uncles, and anyone else who cares can contribute to the account.
Note that laws may vary from state to state, so check each plan’s particular rules.
The tax implications
You cannot deduct 529 contributions on your federal tax return. But many states allow residents a limited deduction or credit against state income taxes for contributions to state-run 529 plans.
Even if you don’t qualify for a state income tax deduction, a 529 plan is still a great way to save for college:
- All growth of investments inside the plan is withdrawn tax-free for approved college expenses, and this applies to any accredited school in any state, no matter which state plan you use to invest.
- The money can usually be transferred between members of the same family, so if a sibling gets a full-ride scholarship, it’s possible that another family member can use the 529 account.
- Assets in a 529 plan count far less against the family in the financial aid formulas than do student assets.
Typically, a 529 plan offers a limited number of mutual funds and the eventual results depend on market performance and your investment choices. Most plans offer age-based funds that promise to become more conservative as your child gets closer to needing the money for college.
One of the best ways to start investigating 529 plans is at www.SavingforCollege.com. You can compare the various plans for performance and fees. You can even link directly from the site to application forms for various plans. It’s worth comparing your state’s plan to those offered by other states since fees can be a drag over the long run of the investment.
Special note for grandparents
Each state has an aggregate maximum for 529 plans for a given student in that state. Grandparents’ contributions can help reach that limit. If grandparents want to make contributions over the state limit, an out-of-state account can be a workaround. According to SavingforCollege.com, “IRS regulations do not prohibit a beneficiary from having accounts in different states with a combined balance that exceeds a state’s aggregate limit. But, any amount above the state’s aggregate limit must be an appropriate amount to cover a beneficiary’s future higher education needs.”
Let us know if you have any questions about starting and funding a 529 plan for a scholar in your family.
About this Author
Nate is a trusted advisor for businesses and individuals, providing tax planning, compliance support, and accounting services. He also is certified as a Personal Financial Specialist which allows him to guide clients through the many challenges and phases of their career from start-up to retirement.