What is a 529 plan?
A 529 plan is a savings account that permits families to save for college with tax-deferred growth.
Also known as a qualified tuition plan, 529 plans receive their authorization from Section 529 of the Internal Revenue Code. States, educational institutions and agencies of the state may all sponsor 529 plans. Parents do not have to use their state’s 529 plan. However, if you use your state’s 529 plan, you may be eligible for a deduction on your state income taxes.
There are two types of 529 plans: prepaid tuition plans and college savings plans. Prepaid tuition plans are not available in every state.
The prepaid tuition plan enables savers to purchase credits for future use. When it is time for your child to attend college, you use the credits to pay for tuition. By purchasing the credits now, you lock in current tuition prices. Some universities permit the use of credits for room and board. To participate in a state’s prepaid tuition plan, you usually must be a resident of the state. Participating in-state universities accept the credits. Should your child decide to attend an out-of-state school, you have options. Some universities will accept out-of-state credits, while others purchase the credits back.
A college savings plan is a general-purpose account to save for college expenses. There are no limitations concerning where you can spend the money as long as it is for qualifying college expenses. The account holder saves money in the account for the beneficiary (the individual attending college). Once you contribute to the account, you have multiple options for investing the money, such as stocks, bonds and cash equivalents. If you use the earnings for items other than educational expenses, expect to pay a 10 percent penalty and income taxes.
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529 plan example
If you want to start saving for college, a 529 plan is an excellent way to do so. For example, assume that you want to contribute $50,000 to your child’s education. Using a college savings plan, you can meet your goal by contributing $2,777.78 a year or $231.48 a month (assuming you start contributions when your child is born). This does not take into account possible earnings on your contributions.
Worried you aren’t saving enough for college? Run the numbers and see how you’re doing.