April showers bring May flowers… and in just a few weeks, 529 Day! May 29th has become an annual “celebration” of awareness for 529 College Savings Plans. In the same way that we use tax-advantaged accounts to save for retirement, 529 Plans can be a great way to save for future education expenses with favorable tax incentives. As with everything in life, there are pros and cons to using this strategy to save for college.
A 529 Plan is an investment program sponsored at the State level. You make contributions to the account which are invested and grow over time. When the account beneficiary is ready for college, you can pay the bills directly from the 529 account. They offer favorable tax treatment that can make saving for college easier and more affordable.
- Contributions – Depending on your State’s rules, some plans will provide a deduction on your State income tax return.
- Growth – Earnings within the account will grow Federal and State tax-free each year.
- Distributions – When you make withdrawals to pay for qualified higher education expenses, you’re not taxed on the distribution at either the State or Federal level!
- Qualified expenses include tuition & fees, room & board, books & supplies, and some computer expenses & required equipment.
- Setting up an account and making automatic contributions each month is very easy! Age-based investment options can make managing the account a breeze.
- Some plans allow for contributions from family members, grandparents, and others.
- Having a college funding “system” in place separate from your other funds promotes disciplined saving.
- If you don’t use all the funds, you can easily change the beneficiary of the account to pay for another child or family member.
- Not every State offers a tax deduction for contributions.
- Investment options are typically limited to those approved by the plan.
- Expenses within the Plan can be higher than some other types of accounts.
- If you want to use the money for things other than qualified education expenses, the earnings will be taxed along with an additional 10% tax penalty.
The tax advantages make the 529 Plan your first-stop for college savings. However the trade-off is that your savings is locked up for the purpose of education. If you’re unsure that your child will go to college or if you think they’ll have other significant resources through a scholarship or inheritance, then it might be best to avoid locking up additional funds for that purpose.
Similarly, saving for your own retirement and saving for your child’s education are actually very easy to prioritize: retirement comes first. You or your child can get a loan or grant for education expenses if needed, but have you ever heard of a retirement loan? They don’t exist. If you find the two are in conflict for you personally, a 529 Plan may not be appropriate. But the good news is there are other strategies that use more flexible account types. You can save to help your child with expenses while also not locking up a significant portion of your resources for one goal.
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