It’s never too early to start thinking about your children’s college education. The sooner you start saving, the greater the chance your child will have enough money to get through college with no worries. But when considering college savings, many parents are unsure just what they should do with the money.
You could stuff it in a sock drawer, but it would have no chance of drawing interest there. A savings account might be slightly better, but any interest earned would be taxed. A 529 plan is a much better option.
529 plans are similar to 401K plans, but they’re for higher education instead of college. Parents, grandparents or anyone else can put money into one for a specified beneficiary. Any interest earned is tax-deferred, and if the money is left in the account until the child goes to college and used for college expenses, there is no tax liability.
There are two basic types of 529 plans. The College Savings Plan is the most similar to a 401K. Investors are allowed to choose from a variety of investment options for the plan, and their money earns interest according to the investments’ performance. The Prepaid Tuition Plan is different in that it allows contributors to purchase tuition credits at current prices to use in the future.
Most 529 plans are run by states. Every state offers at least one plan. Each plan is different, but most require either the plan owner or beneficiary to be a resident of the state issuing the plan. Some allow residents of any state to invest, but out-of-state residents may not be eligible for all available tax benefits. In most cases, the funds from state-run plans may be used at any college or university, even if it is not located in the same state.
There are also 529 plans offered by colleges and universities. All plans offered by educational institutions are prepaid tuition plans. Unlike state-run prepaid tuition plans, however, those run by schools are not guaranteed by the government.
The funds withdrawn from a 529 plan must be used toward eligible expenses. With prepaid tuition plans, these generally include only tuition and mandatory fees. Some plans, however, offer an option to purchase room and board credits or use extra tuition credits for these expenses. Money withdrawn from college savings plans may be used for tuition, fees, books, computers and room and board.
A 529 plan can help you save money for education without incurring a huge tax bill. These plans are easy to set up, and all of the investing is taken care of for you. All you need to do is make contributions and make sure that the beneficiary uses the funds properly when the time comes.