529 plan
A 529 plan is a tax-free investment account established to pay for the higher education expenses of a named beneficiary. The beneficiary must be a family member, and in addition to your own children, you can use this type of plan for a grandchild, favorite niece or nephew, or other young relation.
For colleges:
Qualified tuition plans, also known as 529 plans, are a popular education savings method that feature special tax benefits and allow significantly greater contributions than other options. Every state now has at least one 529 plan. With so many choices, it is important to know the basics about how these plans work and what to consider before you invest.
HOW 529 plan WORK
Anyone can contribute money to a 529 plan on behalf of a beneficiary, and unlike contributors are not subject to income limitations, or are there restrictions on the beneficiarys age. The only requirement is that amount accumulated in the plan must be used to pay for the qualified education expenses of an undergraduate or graduate program at an accredited institution. Expenses that qualify include tuition, fees, books, supplies, required equipment, and room and board.
The two types of 529 plans: PREPAID AND SAVINGS Prepaid Plans. With prepaid plans, you fund future tuition costs by purchasing college credit hours at todays rates. When the credit hours are used, the plan pays the going rate for tuition at that time. Because the tuition money will be there when you need it. Unfortunately, these guaranteed plans normally cover only the cost of tuition. Recently, some states have discontinued offering prepaid plans. If your state still offers one, check it out. The disadvantage of these plans, however, is that they can affect financial aid eligibility.Savings Plans. In these plans, your contributions are invested in mutual funds offered by the plans program manager. Some plans allow you to choose the mutual funds. Others have ready-made investment portfolios based on age and risk acceptance, and the state or program manager efficiently manages these. Remember that investments in 529 Savings Plans fluctuate with the stock market, so they need to be watched regularly just like retirement savings and other investments. You can change your investment selections in a plan or move the plan assets to another states plan once a year.
Requirements and benefits:
Both types of 529 plans are subject to the requirements of the sponsoring state. Many states allow nonresidents to participate in their 529 plan.
Among the benefits of a 529 plan are the following:No federal income tax. According to section 529 of the internal revenue code, earnings from plan investments are free from federal income tax, as long as the funds are used to give for qualified education expenses.State tax deductions. Some states allow a deduction for contributions to the states 529 plan, others may tax out of state plan contributions, and still others follow the federal rules.Estate planning advantages. A dominant estate planning tool, 529 plans permit individuals to make gifts to anyone without reporting the contribution or paying a federal gift transfer tax.
These benefits, coupled with large contribution maximums, make 529 plans smart savings vehicles. However, if you use the money for anything other than qualified education expenses, you face a penalty tax and tax on the earnings subject to that distribution. Special exceptions apply if the student receives a scholarship, dies, or becomes disabled.
Choosing a 529 plan:
A final consideration is the plans impact on need based financial aid. Prepaid plans are considered a student resource and result in a dollar for dollar reduction in financial aid. However, 529 savings plans are considered as the owners asset, not the beneficiarys. These plans are very new, but it appears that private colleges may treat these plans as a student asset, which will be assessed for financial aid formulas. There are other considerations as well, so 529 plans may be most suitable for families who do not expect to qualify for financial aid or who do not want to count on financial aid.
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