Saving for College? Consider a 529

The 529 college savings plan (named after the section of the Tax Code that governs it) is an investment account which allows you to set aside money for your child's education and let it grow tax-free. The money is also not taxed when you withdraw it from the account, as long as it's used for higher education. It may be used at any accredited college or university in the country, and for all qualified higher education expenses, including tuition and fees, room, board and books. Any family can contribute to a 529 regardless of income, and there's a lifetime maximum contribution of roughly $290,000 (this varies by state). Accounts can generally be opened with as little as $25.

What are the advantages of investing in a 529? As stated, there are no annual taxes on account earnings. Invested funds grow tax-free for as long as they are kept in the account. In addition, if you invest in your own state's 529, you could get state tax deductions on contributions or exemptions on withdrawals.

You can open a 529 for any number of people regardless of age. If you have more than one child, you can open one for each. You can also open more than one account for a single individual, or for yourself if you plan to return to school in the future. Grandparents can open accounts for grandchildren, uncles for nieces and nephews, etc. And, you remain in control of the funds; you decide when and how much money to withdraw.

The money you put into a 529 account is considered a gift and, as such, qualifies for the annual $11,000 gift tax exclusion; that is, you can contribute up to $11,000 annually without incurring the any tax. In addition, you can contribute the equivalent of five years’ worth of gifts ($55,000; $110,000 if you’re married) in one year without incurring the gift tax, so long as you don't contribute any more for the next four years. This is also a good way for grandparents to move money out of their estate quickly without incurring taxes.

The 529 does have certain drawbacks, as well. Like all instruments which invest in the stock market, it can increase or decrease in value, depending on market fluctuations. In other words, you could lose some of your money. Additionally, your investment options are limited to what’s offered by the state whose plan you’re using. Most states do, however, offer the opportunity to automatically alter the mix of stocks and bonds in your investment portfolio as your child approaches college age. When your child is younger, the portfolio is composed of more aggressive stocks, and every quarter the mix in the portfolio becomes more conservative until it's composed mostly of bonds when the child has reached college age.

Additionally, if you withdraw the money for non-educational purposes, you’ll have to pay tax on the earnings as well as a 10% penalty. Some states will also levy an additional 10% penalty for early withdrawal.

For a more detailed look at each state’s 529 program, along with tools to help you decide which one is best for you, visit Savingforcollege.com and Collegesavings.org.

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