If you are in a position to put aside money for your children's education, one option you should look into is a 529 plan, an investment vehicle with tax advantages that are designed to save for your children's future college needs.
A 529 plan has benefits like reduced state and federal taxes, scholarship or grant opportunities and, most importantly, is exempt from state financial aid calculations.
There are two kinds of 529 plans: savings and prepaid . In the savings plans, growth is based on the market performance of the investments in the plan, typically mutual funds. Most of these 529 savings plans offer an option where the investments shift to more conservative investments as the covered student gets closer to college age. Prepaid plans, on the other hand, allow you to purchase tuition credits, at current rates, for use in the future. So their monetary performance is based on tuition inflation.
Although plan contributions are paid after tax, there are states will allow you to deduct some contributions from state tax filng. Other benefits include:
- Account earnings are non taxable.
- You control the account, not your child.
- You can use the money for another family member if the child you opened the account for decides not to go to college.
- Contributions can come from anyone.
- Most states do not limit the age when the beneficiary uses themoney.
- If your child wins a scholarship, you can take out the money without penalties, but you will pay tax on earnings.
- Contributions qualify for an annual gift tax exclusion.\
- During the first year, you can contribute up to five times the annual gift tax.
- The money can be used for your child to attend any accredited degree-granting educational institution.
- Most states count tuition, books, room & board, transportation and computers as educational costs.
- A prepaid tuition option lets you or anyone else pay tuition in advance at today’s tuition rates.
Of course everything in life has drawbacks. Some reasons you may not wish to use a 529 plan include:
- A 529 account can affect your child’s ability to get financial aid.
- The money in the account is not eligible as loan collateral.
- You control the account, but not the investments. The plan administers investments.
- If you withdraw money for non-educational reasons, you pay tax plus a 10 percent penalty.
- You cannot contribute with stocks… only cash.
- A 529 account is considered a gift and cannot be calculated as part of estate assets.
- You must have a separate account for each beneficiary, not one account for all your kids. You can rollover unused funds to another account, however.
You can find out more about 529 plans and how they gained their current tax advantages at the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Another great resource is this particularly well-done website that has extensive information by state, studies on the lowest-cost 529 plans, and more: savingforcollege.com.