For those who want to save for college and/or invest in K-12 tuition, any 529 plan makes money management convenient and provides a few tax benefits.
There are two types of 529 plans:
Prepaid tuition plans: This lets you pay in advance all or part of the expenses of an in-state public college education. It also offers the flexibility to be converted for use at private and out-of-state colleges. Importantly, educational institutions can offer a prepaid tuition plan but not a college savings plan.
College savings plans: This saving vehicle is similar to a Roth 401(k) or Roth IRA, where you invest an after-tax amount in certain preset investment options like mutual funds, ETF portfolios, and a principal-protected bank product. The value of the plan account goes up or down based on the performance of the investment options.
Investment portfolios in college plans may include static fund portfolios and age-based portfolios. Age-based portfolios work like target-date funds, gradually shifting toward more conservative investments as the beneficiary gets closer to college age. Static fund portfolios have the same asset allocation over the life of the plan, unless manually changed by the plan owner.
These plans are offered by the states, and provide the flexibility to invest in any state 529 plan, regardless of the state of your residence and university.
What can a 529 plan be used for?
College savings plan funds can be used at any college or university, including at non-U.S. colleges and universities in some instances. Withdrawals can be used to cover qualified education expenses, including tuition, mandatory fees, equipment, computers, books and supplies, as well as room and board.
$10,000 can be withdrawn per year per student to pay for primary or secondary education expenses.
Tax implications of investing in a 529 plan
Similar to a Roth IRA, post-tax dollar contributions are made to a 529 plan and are not deductible from federal income taxes. Earnings grow on a deferred-tax basis, and distributions are not federally taxed when used for qualified education expenses. This allows annual growth in the original investment to be free from federal and state income taxes.
Further, the federal tax law may provide special tax benefits, such as a five-year gift tax averaging while states offer state income tax incentives like state income tax deductions and tax credits for contributions to the state’s 529 plan.
However, if distributions are not considered as qualified expenses, the earnings portion of the distributed investment will be subject to federal income tax and can incur a 10% penalty.
Flexible Rules
These plans offer immense flexibility. Anyone can enroll in a 529 plan on behalf of the beneficiary. And if the beneficiary does not apply for college and the money remains unused, the account holder can change the beneficiary to any immediate family member, friend or descendant of the original beneficiary.
Is a 529 college savings plan rational?
As the cost of higher education is rising, saving for college is essential. While the 529 college savings plan requires understanding of rules related to qualified expenses, the tax benefits and flexibility of these plans make them worth it.
To make your college savings work for you, it is important that you know the laws and are aware of what you can use your 529 plan for. Importantly, you should review the fees and expenses associated with these plans as they can lower your returns. To remain competitive, 529 accounts are slashing their fees, so it might be a good idea to compare fees of any investment portfolio before deciding which 529 plan to choose.
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What to Know About 529 College Savings Plans
For those who want to save for college and/or invest in K-12 tuition, any 529 plan makes money management convenient and provides a few tax benefits.
There are two types of 529 plans:
Prepaid tuition plans: This lets you pay in advance all or part of the expenses of an in-state public college education. It also offers the flexibility to be converted for use at private and out-of-state colleges. Importantly, educational institutions can offer a prepaid tuition plan but not a college savings plan.
College savings plans: This saving vehicle is similar to a Roth 401(k) or Roth IRA, where you invest an after-tax amount in certain preset investment options like mutual funds, ETF portfolios, and a principal-protected bank product. The value of the plan account goes up or down based on the performance of the investment options.
Investment portfolios in college plans may include static fund portfolios and age-based portfolios. Age-based portfolios work like target-date funds, gradually shifting toward more conservative investments as the beneficiary gets closer to college age. Static fund portfolios have the same asset allocation over the life of the plan, unless manually changed by the plan owner.
These plans are offered by the states, and provide the flexibility to invest in any state 529 plan, regardless of the state of your residence and university.
What can a 529 plan be used for?
College savings plan funds can be used at any college or university, including at non-U.S. colleges and universities in some instances. Withdrawals can be used to cover qualified education expenses, including tuition, mandatory fees, equipment, computers, books and supplies, as well as room and board.
$10,000 can be withdrawn per year per student to pay for primary or secondary education expenses.
Tax implications of investing in a 529 plan
Similar to a Roth IRA, post-tax dollar contributions are made to a 529 plan and are not deductible from federal income taxes. Earnings grow on a deferred-tax basis, and distributions are not federally taxed when used for qualified education expenses. This allows annual growth in the original investment to be free from federal and state income taxes.
Further, the federal tax law may provide special tax benefits, such as a five-year gift tax averaging while states offer state income tax incentives like state income tax deductions and tax credits for contributions to the state’s 529 plan.
However, if distributions are not considered as qualified expenses, the earnings portion of the distributed investment will be subject to federal income tax and can incur a 10% penalty.
Flexible Rules
These plans offer immense flexibility. Anyone can enroll in a 529 plan on behalf of the beneficiary. And if the beneficiary does not apply for college and the money remains unused, the account holder can change the beneficiary to any immediate family member, friend or descendant of the original beneficiary.
Is a 529 college savings plan rational?
As the cost of higher education is rising, saving for college is essential. While the 529 college savings plan requires understanding of rules related to qualified expenses, the tax benefits and flexibility of these plans make them worth it.
To make your college savings work for you, it is important that you know the laws and are aware of what you can use your 529 plan for. Importantly, you should review the fees and expenses associated with these plans as they can lower your returns. To remain competitive, 529 accounts are slashing their fees, so it might be a good idea to compare fees of any investment portfolio before deciding which 529 plan to choose.
A Simple Way to Build Wealth
No matter what your financial goals are, investing in quality stocks is an option worth considering. Stocks have produced better returns than other kinds of investments over the years and generated significant wealth for shareholders. If you're interested in stocks but are nervous about picking the right ones, Zacks can help.
Our research team makes it simple to find long-term buys with long-term wealth-building potential. Starting today, you can see our private selection of stocks priced under $10, Warren Buffett-style value picks, dividend stocks and more. Click here for your sneak peak >>