I’d like to make sure that my daughter doesn’t accumulate the same amount debt from attending college when she gets older that many people in my family have. Should I be investing in a 529 on her behalf? Erika – Chicago, Illinois
In layman’s terms, 529 plans are simply investment accounts where your money can grow free from federal income tax and withdrawn federal income-tax free if used for “qualified higher education expenses.” These expenses are laid out in detail in each states particular 529 plan offering, of which there can be many to choose from. Another great perk of 529s is that many have added state tax benefits. For example, residents of Illinois who contribute to that states’ 529 pay no state tax on earning and withdrawals for qualified expense and contributions of up to $13, 000 per parent, per year are tax deductible. But beware, if you decide to use this money of anything other than education you will be asked to pay the taxes on your earning and you’ll be hit with a 10% federal tax penalty.
Since each state can have several options for these 529 Plans, how do you go about finding one that is right for your particular situation?
Okay, let’s break down the two types of 529 plans so that folks won’t get the feel of being overwhelmed, because with so much information available it definitely can be overwhelming. Over 12 million 529 plan accounts have been opened since the tax code that the plan gets its name was refined in 2001, so you are in good company.
First, we have the Pre-Paid Tuition Plan. According to the College Saving Plans Network these are only currently offered in 12 states. So if you go this route your choice will be limited simply by its restricted availability. Basically, this plan allows its savers to purchase college credits at participating institutions at current prices. Essentially you are locking in today’s prices for your child’s future education. A big benefit of this type of 529 is that the state or education institution that offers the plan will in most cases guarantee the investment. The big downside to this plan is that there will likely be residency requirements. So if you don’t live in one of the 12 states that offer this plan you are out of luck.
The second type of 529 plan, and frankly, the more exciting of the two in my opinion is simply called the College Savings Plan. This plan doesn’t lock in the tuition costs or provide guarantees like the other 529, it actually invests your money thus giving your child’s educational funds access to one of the greatest wealth builder of the modern era, the stock market. But this isn’t its only advantage. For instance:
· Lifetime contribution limits of up to a maximum of $300,000 are possible with many College Savings Plans. So you’ll be able to fund them up to the specified maximum limit without other limiting factors. Pre-paid Tuition Plans on the other hand generally set payments based on age and number of years of college tuition purchased.
· College Savings Plans are available regardless of age. Think you’ll be heading back to school in your fifties, no problem, start saving. Pre-paid’s, for the most, part have age and/or grade limits for the beneficiary.
· Want to get started right away? College Savings Plans have open enrollment so go ahead.
· College Savings Plans will allow you, without penalty, to use your funds for educational expenses that aren’t necessarily tuition or mandatory fees. You can use your savings to cover room and board and even books and computers if they are required. The average annual room and board, according to a recent U.S. News and World Report article, is $9,407. Not exactly peanuts and that amount wouldn’t necessarily be covered by a Pre-paid plan.
· And last but certainly not least, College Savings Plan doesn’t have residency requirements. There are oftentimes some benefits for residence like reduced fees but if you see a great plan in another state you can start investing.
With tuition as well as room and board up nearly 50% over the last decade you can be assured that in another ten or twenty years it will be a very costly proposition. Choosing one of the 529 plan types is a great option.
If each state allows non-residents to enroll in their College Savings Plan 529s, I imagine that the plans must be at least a little different so that they can compete against each other. How do we differentiate between the options?
You are exactly right that the plans are all slightly different in the hopes of attracting more investors. Here are a few of the questions you’ll need to ask is what you’ll need to be aware of in order to make an educated decision:
· Does your particular state’s plan offering allow for a discount of fees because of residency? If so it could offset other fees or expenses and make it more attractive.
· Is the plan direct-sold or advisor sold? If it is advisor sold you will probably be paying a bit extra for their expertise.
· What is the minimum contribution? This question can very quickly eliminate some options if don’t have much money to get the ball rolling.
Really great 529 Plan comparison tools and information can be found at www.collegesavings.org and www.savingforcollege.com. Both sites will walk you through most questions that you will make and many more that never occurred to you.