One of the most important decisions for parents and grandparents to make if they hope to fund a college education for their children and grandchildren is to determine the best type of college savings plan to use. In recent years, 529 plans have grown in popularity and become the most common college saving vehicle. There are several advantages to a 529 plan compared to other options available, including bank savings accounts, custodial accounts, and Education IRAs. 529 plans offer 5 distinct advantages over these types of accounts.
Tax Management: From a tax standpoint, 529 plans can’t be beat if the money is used for expenses related to college. You don’t get a tax deduction when you contribute, but the money you put into the plan grows on a tax-deferred basis and the distributions taken are completely tax-free if the money is used for college expenses. Depending on the state you live in, there could be state tax advantages as well, including an upfront deduction for 529 plan contributions made in some states.
It’s important to understand that the earnings in a 529 plan are taxable if they are used for non-college related expenses, and a 10% federal tax penalty is incurred, so it’s important to make sure the money is likely to be used for education expenses.
Control: One of the drawbacks to many traditional college savings accounts is that the child can legally take control of those funds when they reach adulthood. In a 529 plan, the owner of the account controls the funds at all times and can decide when the money can be taken out of the account. If the owner decides to withdraw the funds and use them for their own purposes, most plans will not stand in the way.
Convenience: There is a stack of paperwork required to open a 529 plan, just like any other financial account, but once the account has been establish, a 529 plan is a very easy way to save for college. In most cases the owner can either choose from an age-based or a risk-based portfolio, which is then professionally balanced and monitored until the funds are needed. You don’t have to spend hours researching investment strategies in order to take advantage of the benefits of saving for college.
Flexibility: With a 529 plan, it’s easy to change investment options or even rollover the money into a 529 plan sponsored by a different state at no cost. It’s also possible to replace a beneficiary with another child in the family if those funds could be better used to benefit a child other than the original beneficiary. Since we can’t always tell which of our children will pursue a college education when we begin saving for them, the flexibility of these plans allows you to use the money where it makes the most sense for your family.
Contribution Limits: With a 529 plan, there are no limitations as to who can invest. Many investment vehicles, especially those that feature tax deferral, have strict income requirements. Also, some college savings plans, such as Education IRAs, have strict contribution limits that make it difficult to grow the account quickly. A 529 plan allows anyone to contribute, regardless of income and without an annual contribution limit. Many plans allow overall contributions in excess of $300,000 for each beneficiary.