When the topic of College Savings comes up, most parents have the same questions. Should I start saving? When should I start? What type of account should I open? What if my child decides not to go to college?
If you are in an income bracket in which you know you will have to pay at least part of your child’s college expenses out of pocket, not taking into account any possible scholarships, it is never too early to start saving. An account can be opened for your child as soon as the child has a social security number. You can invest as little as $25 per month in some accounts. The sooner you start saving, the less money you will need to contribute either periodically or in a single payment in order to have enough money accumulated to cover your child’s college expenses. The most common savings tool for college is the 529 Plan.
What is a 529 Plan? A 529 Plan is an education savings plan operated by a state or financial institution. It is intended to help parents set aside money for future college costs. The plan is named after the Internal Revenue Code which created these types of accounts in 1996. 529 Plan contributions are eligible for deductions to Federal Income Tax. State Income Tax deduction eligibility is dependent upon the state. There are two types of 529 plans: a Savings Plan and a Prepaid Plan. The Independent 529 Plan (a Prepaid Plan) is the only institution-sponsored plan thus far.
The 529 Savings Plan works much like a retirement plan. You have a list of options that may include age-based or investment strategy-based portfolios managed by the state or individual mutual funds. These investments are market sensitive and will go up and down based on the performance of your particular investment choice. The investments grow tax-free, and any distribution taken for qualified higher education expenses are tax-free. Savings Plans may be used at any institution that is eligible for Federal Student Financial Aid, so you can pick from any state’s plan that does not have residential requirements if it is not your or the beneficiary’s resident state.
The 529 Prepaid Plan allows you to prepay all or part of future college tuition and fees and qualified college expenses. What the prepaid plan actually pays depends on the state’s plan. Most of these plans have residency requirements and not all states offer a prepaid plan. The prepaid plan allows you to “lock in” at the current tuition plus an additional premium to help keep the plan fiscally sound. All the state-provided plans cover only in-state public college tuition and fees. The Independent 529 Plan is covered by a consortium of private colleges and currently includes 274 private colleges.
If your child decides not to attend college, decides to attend college out of state or receives a scholarship, you still have options for the plan. Some of your plan options may include transferring the plan to another beneficiary, using the money toward skills training programs or overseas education programs that are eligible for Federal Student Financial Aid, or withdrawal from the plan altogether. If your child decides not to attend college or a skills training program, the plan may be transferred to fund the education of another beneficiary who is related to the original beneficiary (i.e. brother or sister, cousin, mother or father, son or daughter). Keep in mind that for most plans the child has up to ten years from the expected date of high school graduation to use the funds with the ability to extend for up to 30 years with written request to some plans. If your child receives a scholarship, you may withdraw an amount equal to the amount of the scholarship from the plan to use for other than qualified college expenses without penalty. If your child decides to attend college out of state and you have purchased a prepaid plan, you can still use the prepaid plan to pay for college expenses. The amount you will receive for each unit or year of the in-state prepaid plan to pay for the out of state college will be the amount you put in plus a reasonable interest rate or plan performance or the average in-state tuition depending on the prepaid plan you purchased. Some state prepaid plans will even pay the full tuition no matter what state you attend college. If you are still not interested in keeping the plan, you may cash out of the plan. You will be responsible for taxes on any interest on contributions made as well as a recapture of any tax deductions you’ve taken on the contributions. So even if your child does not make traditional use of the 529 Plan account you have opened for his/her benefit, you still have many options for the plan.
Savings for a child’s college education is a very important decision to make. The 529 Plan is only one of the options and is the one briefly described above. To find out more about the 529 Plan and other options for saving for college, a good place to start is the savingforcollege.com website. Celebrating 529 College Savings Day, May 29, 2012, the website is currently offering the free download of its Family Guide to College Savings, written by Joseph Hurley, their “529 Guru.” You should also discuss with your financial advisor your savings options and how much you could/should save.