A piggy bank with a graduation cap with a one dollar bill in the background
Education-savings plans

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.

College savings at a glance
Coverdell education
savings account
529 college savings plans
  • Federally sponsored
  • Limit to annual contributions
  • Contributions are not tax-deductible
  • Tax-free withdrawals for qualified education expenses
  • Contributions may be placed into any qualifying investment vehicle
  • No limit on number of Coverdell rollover options available or incur a taxable situation with penalty
  • State sponsored
  • Not tax deductible
  • Tax-free withdrawals for qualified education expenses
  • Two types: prepaid tuition and savings plan eligibility for financial aid
  • Each savings program offers investment choices
  • If not used: options to hold a savings plan, transfer plan to a family member or cash out and pay a penalty.

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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