Parents expecting to have kids or parents with infants usually wonder how they will get their kids through school in the most cost-effective way. Some may just continuously put money aside from every paycheck or others not plan for this at all because they do not know the proper way to do it. One good way to save for school that will provide tax benefits for you is called a 529 plan. A 529 plan is a college savings plan that provides you with tax benefits but can also be used to save up for tuition from kindergarten to high school. Most states have 529 plans, and you are not limited to the state in which the plan is set up. The plans can be used for colleges in any state.
529 plans are grouped into two categories:
- College Savings Plans: several investment options are offered, and the value of your account would depend on how well the invest options perform. You contribute your after-tax contributions, like a Roth IRA.
- Prepaid Tuition Plans: pay tuition costs in advance for public colleges that are in-state, and it can be changed to be used at private colleges or religious K-12 schools instead. The tax benefits of this plan make it appealing for parents to use for their kids. This plan allows your earnings to grow in this account tax-free and it does tax-free withdrawals when used for qualified expenses up to $10,000 per year, per beneficiary. Qualified expenses include:
- Tuition and fees
- Books and materials
- Room and board (for students enrolled at least half-time)
- Computers and related equipment
- Internet access and special needs equipment for students attending a college university, or other eligible post-secondary educational institutions
- Transportation costs and health insurance are not considered qualified expenses.
Distributions may also be used to pay student loans. The only distributions that can be taxed from this account are distributions made for non-qualified expenses. These are taxed at a 10% rate. The fees of a non-qualified withdrawal may only be waived for three instances:
- Beneficiary joins the military
- Beneficiary dies or becomes handicapped
- Beneficiary accepts a tax-free scholarship
Some other ways to avoid, but not waive the fee, would be to change the beneficiary to someone else/yourself or just hold it in case the beneficiary decides to pursue further education past undergraduate work. Your contributions are not tax deductible from the federal income taxes, but some states do offer tax deductions for you. Personally, I pay for college through my student loans and it is not bad for now, but of course eventually I will have to pay that back. This plan can help take some of the load from your kids when it comes to tuition and having to pull out and payback loans for it. Still not convinced that a 529 plan is the saving tool for your kid’s education? I will leave you with some benefits of the plan to keep in mind:
- You stay in control of the account and it is very low maintenance. You can forget about it and set up automatic deposits and it will still be okay. The payments can be however much you want to (just requires a $25 initial deposit.)
- Besides its tax breaks, it is simple for tax reporting because you are not required to report these contributions on your federal tax return
- Everyone, regardless of income or age, is eligible for this 529 plan