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With a savings plan, parents open an account
and choose an investment strategy. Typically, if you start the plan
when the child is very young, you'd begin with some aggressive investments
and gradually switch to more conservative options as the child grows.
Withdrawals are tax-free when it's time to pay a son's
or daughter's college expenses including tuition, books and room
and board. It's essentially a 401(k) dedicated to paying
for college expenses.
Each savings program offers parents several different
investment choices. Many state programs are open to nonresidents,
so it makes sense for parents to shop around for a plan that best
meets their financial and educational needs.
What happens if the child decides not to go to college?
A parent has three basic choices: hang on to the savings
plan, transfer it to another family member or cash out and pay a
penalty.
Some parents hang on to the 529 plan in case the child
decides to attend college at a later date. Others transfer the account
over to another family member.
Some parents decide to cash out the plan and pay a
penalty. Most states collect a penalty of 10 percent of the earnings
on any withdrawal that is used for noneducational purposes.
A federal penalty equal to 10 percent of earnings
will be charged, as well. No penalty will be assessed if a beneficiary
should die or become disabled.
While the tax-free withdrawals clearly make 529 plans
attractive financial options, they may not be right for every family.
Participating in a 529 prepaid tuition plan affects a family's eligibility
for financial aid. It's considered a resource for the student like
a scholarship. It reduces financial aid on a dollar-per-dollar basis.
Some financial advisers urge lower-income families,
who are likely to receive a large amount of financial aid, to pass
on 529 prepaid tuition plans.
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College savings at a glance |
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Coverdell education
savings account
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529 college savings plans
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Participating in a college savings plan also impacts
financial aid, but not as severely. A family with a college savings
account will see their eligibility for aid decrease by as much as
5 percent or 6 percent of the account's value.
College savings plans may make the most sense for
upper income families who won't qualify for financial aid and for
middle-income families who qualify for loans and little else.
State-by-state
program listing
A state-by-state listing of programs is available
on the Web site of the College
Savings Plans Network and on Savingforcollege.com.
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Chapter
5: Savings with tax breaks
