If you want to send your children to college, starting to save while they are young will leave you better prepared to handle the expense. We all know that it’s best to put money into something that will draw interest, but what about the tax implications? Wouldn’t it be great if we could invest in something similar to a 401K that would pay out tax-free when it was time for college?
Actually, we can. It’s called a 529 plan, and it offers the opportunity to save up for higher education without forfeiting a percentage of the interest earned to the government. Named from Section 529 of the Internal Revenue Code, 529 plans have only recently become well known. But their tax advantages have led to a boom in popularity, and they are currently one of the top methods of saving for college.
The 529 plan offers a number of tax advantages. These include the following:
* Contributions may be deducted from state income tax in many states. This can reduce one’s state tax liability each year.
* Interest accrued in a 529 plan is tax-deferred. Early distributions and withdrawals that are not used for education expenses may be subject to taxes and penalties. But if the funds are used strictly for the higher education of the beneficiary, they are exempt from both federal and state taxes.
* Most states have high maximums for contributions to a 529 plan. Some allow for contributions of as much as $300,000 per beneficiary. That allows for a significant amount of interest to accrue tax-free.
* A 529 plan can be useful in estate planning. The assets in the plan are not counted as part of the owner’s estate, yet they can be reclaimed at any time. Reclaiming the assets usually results in income tax and penalties, but the estate tax may be reduced without using the money for education in some cases.
* In the event that a 529 account loses value, the funds may be withdrawn and the losses deducted from taxes.
In addition to tax advantages, 529 plans are advantageous in several other ways. These include:
* All investments are handled by the program manager. All the plan owner has to do is choose the type of investment he wants to pursue and make contributions. The rest is taken care of by knowledgeable investors.
* A 529 plan can be set up so that it does not affect eligibility for financial aid. Accounts owned by students and parents can hurt eligibility, but if the account is set up by a grandparent or other individual, the amount is not considered in figuring the family contribution.
* Prepaid tuition plans are often backed by the state. This means that they cannot lose value.
A 529 plan can be used to ensure that your child has the opportunity to go to college. And unlike many other investments, its interest is not subject to taxes. If you’re looking for a way to save for education without losing a portion of the interest gained, a 529 might be the plan for you.