Stumped On How To Save For College? Consider A 529 Plan

Let’s face it-- higher education isn’t cheap and planning ahead has become more critical than ever. But, sadly, most people don’t know where to begin.

So how can you avert the burgeoning student loan crisis? By choosing the right college savings action planfor you. While there are a number of popular ways to save, one that has gained a considerable amount of attention is the 529 plan -- a tax-advantaged savings account designated specifically for future higher education costs and governed under Section 529 of the IRS code.

What Makes The 529 Plan So Advantageous?

The benefit of the 529 plan over a traditional taxable account is that the investment gains grow and can be withdrawn tax-free, similar to the Roth IRA. Moreover, many states offer additional tax benefits to local residents who invest in their respective state’s plan.

Navigating Your 529 Choices.

When determining your action plan, consider these aspects of your 529: tax benefits and plan specifics.

Tax benefitsvary on a state-by-state basis. For example, Indiana offers an actual tax credit, while most other states offer an annual deduction on taxable income. Some states, such as California and Massachusetts, offer no tax benefits to local residents. In these cases there is no reason for residents to use an in-state plan unless it is superior to out-of-state plans.

Plan specificsof 529s are largely investment options and fees. Most states offer two investment methods: static and age-based. Static implies purchasing funds individually. Age-based refers to pre-set allocation that changes automatically as the beneficiary ages and nears college. Fees vary significantly by plan and can be charged for enrollment applications, account maintenance, program management, and the expenses of underlying investments.

What If Our Child Doesn’t Use It All?

If a child does not attend college, money can be transferred to another qualified beneficiary to be used for education, including immediate family members, relatives of your immediate family, in-laws, and first cousins. A 10% penalty and ordinary income tax are charged on investment gains for non-qualified distributions. There is no penalty or taxes on principal.

When Does a 529 Plan Make Sense?

529 plans are primarily geared towards investors fairly certain the beneficiary will attend college. Most plans offer valuable tax benefits and can be an attractive option for more “hands-off” investors, provided an aged-based option is available. But there are tradeoffs. If fees are high, the tax benefits could begin to fade relative to purchasing low cost exchange-traded funds (ETFs) elsewhere.

Always Keep in Mind Alternatives.

A Roth IRAmay be best if you’re unsure your child will attend college or if you want to maintain monetary flexibility. With a Roth, you save after-tax dollars and the investments grow tax-free. You can then access principal and earnings for qualified educational expenses, with the principal tax-free. Just make sure you know your plan’s investment and income limits, which will vary based on factors like household size and age.

Traditional IRAsoffer the same benefit of tax-deferred growth, and you can withdraw money penalty free for qualified educational expenses at any age. Unlike a Roth, however, you still need to pay income tax on the entire withdrawal.

Taxable accountsoffer the greatest flexibility as there are no savings limits and you maintain full control over the underlying investments. Their primary drawback is a lack of any tax benefit.

In the end, there are many plans to choose from, and the best option will depend on what is best for you and your family.