College tuitions continue to rise, but you can help offset your child’s costs by opening a 529 plan. Learn what a 529 plan is and how it may benefit you and your child.
The cost for higher education continues to grow. On average, students pay $7,020 per year in tuition and fees for public in-state colleges ($11,528 for out-of-state). And if your child is attending a private four-year college? Expect to pay $26,273 per year. And these costs will continue to rise. Between 2000 and 2010, tuition increased at an average annual rate of 4.9 percent beyond general inflation—more rapidly than in either of the previous two decades.
Luckily, a number of options exist for you and your child to save and pay for college. One savings vehicle that continues to grow in popularity is the 529 plan. Created in 1996 and named after Section 529 of the Internal Revenue Code, a 529 plan is an education savings tool operated by a state or educational institution.
How does a 529 plan work?
A 529 plan enables families to set aside money now for future college expenses. Every state offers at least one 529 plan, although state plans can differ from one another. You can enroll in a 529 plan directly with a 529 plan manager or through a financial advisor. As the donor of the plan, you stay in control of the account—which means you have control over when and how money in the account is used. The plan is managed and maintained by your state’s treasurer’s office or an outside investment company.
Where can a 529 plan be used?
You or your child can use the funds from a 529 plan at any qualified college nationwide. Live in Arizona but want to go to college in Connecticut? You can do that. And, depending on the type of plan you choose, your funds can be used for private institutions as well.
What types of 529 plans are available?
Two basic 529 plans are available: a savings plan and a pre-paid plan.
- Savings plans offer several investment options for you to select from and operate much like a 401(k) or IRA. The growth of your account will depend on the performance of the options you choose.
- Pre-paid plans are just that—they enable you to pre-pay all or part of the costs of a college education.
Some private colleges also offer their own pre-paid programs as well. Each participating college has its own type of plan, however, so be sure to research the particulars first.
Are there any tax benefits associated with a 529 plan?
Yes. Your investment in a 529 college savings plan grows tax-deferred and qualified distributions are tax-free at the federal level. Some states offer additional tax benefits as well. In addition, your donation into a 529 plan can qualify for the annual federal gift tax exclusion as long as your gift does not exceed $13,000.
What happens if the 529 plan isn’t used?
Any earnings for non-qualified distributions from a 529 plan are subject to a 10 percent penalty and income tax (at your tax rate). Principal is not subject to these penalties. And, any deductions you claimed for the 529 plan on your state income tax return will generally need to be reported as “recapture” income. Exceptions can be claimed if the plan is not needed because the beneficiary was disabled, died or received a scholarship.
You can minimize these penalties by transferring the beneficiary of the 529 plan to another qualifying family member.
So, now that you know what a 529 plan is and how it works, how much should you save for your child’s education? Check out Fidelity Investment’s college savings guidelines for families earning $55,000, $75,000 and $100,000.
This article contains general information. Individual financial situations are unique; please, consult your financial advisor or tax attorney before utilizing any of the information contained in this article.
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