529 Plans to the Rescue

By the time infants born in 2016 turn 18, the cost of their college educations may top $200,000. That’s if they attend an in-state, four-year public university, and the $20,000 the College Board estimates they’d pay for tuition, room and board rises at an average of 5% annually. One investment parents can use to save for these costs is a 529 plan. The name comes from the Internal Revenue Code section that authorizes the plans, legally known as “qualified tuition programs.” Most plans are sponsored by a state or state agency.

Flexibility is King

Anyone can open a 529 plan. The account holder can name a child, grandchild, friend, or even himself or herself as the beneficiary.

Investment options for 529 plans typically include stock and bond mutual funds, as well as money market funds. Some plans offer age-based portfolios that automatically shift to more conservative investments as the beneficiaries near college age.

Earnings in 529 plans typically aren’t subject to federal tax, so long as the funds are used for the beneficiary’s qualified educational expenses. Qualified educational expenses include tuition, room and board, books, fees, and computer technology at most accredited two- and four-year colleges and universities, vocational schools, and eligible foreign institutions. Most states offer full or partial state income tax deductions or other favorable tax incentives to residents making plan contributions. In certain instances, the benefits extend to nonresidents who are subject to tax in the state.

You’re not required to participate in your resident state’s plan. You may find you’re better off with a nonresident state’s plan that offers a wider range of investments or lower fees. Similarly, you can invest in a plan from one state, and the plan’s beneficiary can attend college in another state. For example, you may live in New York and invest in a plan from California, while the plan’s beneficiary attends school in Florida.

The Downsides

While 529 plans can help save on taxes, there are some downsides. Amounts not used for qualified educational expenses may be subject to taxes and penalties. A 529 plan may also reduce a student’s ability to get financial aid, as the money in the plan isn’t an “exempt” asset. That said, 529 plan money is generally treated more favorably than, for instance, assets in a custodial account in the student’s name.

Similar to other investments, investments within 529 plans can fluctuate with the stock market. Some plans charge enrollment and asset management fees.

Work with a Pro

Because the rules surrounding college savings plans can be complex, make sure to consult with your financial advisor or accountant. He or she can help you determine your best options.

© 2016

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