College tuition. These two words strike fear in the hearts of parents.
In 1996, the Internal Revenue Service (IRS) allowed for states to operate college savings plans. These investment plans were given the name 529 because they came from Section 529 in the U.S. tax code. Creative, right?
The way it works is simple. You set up a plan for a single beneficiary. For most, this will be your child. The plans allow for after-tax contributions, and these contributions are placed into an investment fund (So, yes, there is risk involved). Some states let you select from a few funds, others don’t. All growth within the plan and withdrawals are tax-free. So when Susie is ready for college, you are able to withdraw from the account, tax-free, as long as the money is use for qualified expenditures (tuition, fees, books, supplies, and equipment required by the school).
So why should you consider setting up a 529 Plan? Let me give you seven reasons.
- College is expensive. And it is going to get more expensive. Of course, you have already heard this. College has averaged around a 5% increase each year over the past 10 years. Let’s just say that college is costing around $21,000 per year right now. If the 5% increase continues, you will need over $215,000 to pay for college in 18 years. Yikes. If this doesn’t scare you into investing for your kid’s college, I don’t know what will.
- Tax-free withdrawal is a really big deal. The last thing you need is for the government to take part of your college investment earnings. But that it exactly what will happen if you use a regular investment account or place money in a CD. You get taxed on your wise decision to set aside money for college. 529 Plans protect you from this.
- You are not stuck with your state’s plan. In fact, you can choose any state plan you want. Do you live in Tennessee but like Alaska’s plan? You can get Alaska’s plan. Or Maryland’s. Or Utah’s. And you are not stuck with one account either. You can have multiple 529 Plans from various states for a single beneficiary. What would drive you to another state’s plan? The key factor in determining which plan to choose—performance.
- Some states offer additional tax benefits. Before deciding which state plan to choose, check to see if your state offers any additional benefits for investing in their plan. Some states offer their residents additional state tax benefits. Of course, be sure to weigh the plan’s performance as well.
- You can change beneficiaries. What if Susie doesn’t go to college? What if she gets a full scholarship? Or what if you don’t use all of the funds in Susie’s 529 Plan? You can change beneficiaries. They must be a member of the beneficiary’s family. This includes siblings, parents, stepparents, nephews, nieces, aunts, uncles, in-laws, and first cousins.
- Many allow anyone to contribute. If others want to contribute to the beneficiary’s college savings, they can. Of course, they will lose control of funds. If the plan does not allow others to contribute, they can always set up their own 529 Plan for the same beneficiary.
- There are some great sites out there to guide you along. My favorite site is savingforcollege.com. It is rich with information and can help find a 529 Plan that works for you.
Saving for college is a daunting task. And if you are a parent with multiple kids, it can be a terrifying thought. Many try not to think about it. However, the worst thing you can do is to ignore the financial reality that looms. Avoiding your financial reality is a sure way to avoid financial success. Whether you choose a 529 Plan or not, start setting aside money for college expenses. Your future self will be glad you did.