College tuition is on the rise, and parents understandably may feel overwhelmed. But there are steps you can take, such as establishing and contributing to a 529 college savings plan, that can help you reach your goal. "529s are tax-advantaged plans that can be used to meet costs of qualified colleges nationwide and even may be used for some international schools," says Judith Ward, CFP®, a senior financial planner at T. Rowe Price.
529 PLAN CONSIDERATIONS
Some parents think that saving for college will affect their ability to receive government-funded financial aid. In reality, the amount you've saved in certain accounts will have a minimal impact. It's your current income that has the greatest influence on determining your child's financial need. "People think federal aid is going to be free money," says Ward. "They don't realize how much they'll have to pay back later. Saving through a 529 plan can help reduce the amount of debt you amass." (See the "Saving and Financial Aid" sidebar.) Some of the benefits of 529 plans include:
- Savings can be used at nearly any college in the country.
- Anyone can contribute to an account, including grandparents, who can help their children and grandchildren by contributing to a 529 already established—or by starting their own.
- You can open a 529 plan for yourself if you're going back to school.
- Generally there are no income limitations or age restrictions, and many state plans allow you to invest more than $300,000 per beneficiary.
Given the options available under the plans, you will have significant control over the management of the account:
- You decide how much to invest and which investment options to choose.
- Once a year, you can change the investment options and/or transfer your account to a different state's program.
- If your child decides not to go to college, you can transfer the account to benefit another family member.
- The account owner—not the beneficiary—remains in control.
- Most plans even allow you to reclaim the funds for yourself at any time for any reason. There could be various tax consequences, so be sure to speak to your tax advisor first.
Choosing a Plan
Contributing to a college savings plan offers tax-deferred growth potential. The money you set aside also may be tax-deductible at the state level. Any withdrawals used to pay qualified higher education expenses—such as tuition, books, and room and board—are free of federal income tax and may be state tax-free as well. However, the earnings portion of a distribution used for nonqualified expenses may be taxable and subject to a 10% penalty. 529 plans vary from state to state, and each has somewhat different costs, investment options, and tax incentives. A good game plan is to compare the 529 plans offered by your state against others to determine which may be best for you. Says Ward, "The important action is to save—and to begin as early as possible."
Please note that a 529 plan's disclosure document includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. State tax benefits are generally only available to residents of that state. Earnings on a distribution not used for qualified expenses may be subject to income taxes and a 10% federal penalty. The availability of tax or other benefits may be conditioned on meeting certain requirements such as residency.Illustration by Ken Orvidas