What is a 529 plan and why do I need it?
It’s no secret that college in the US is insanely expensive and the price tag of a college education keeps rising every year. Most parents dream of having enough savings to pay for the college expenses of their children and if you’re a parent of a young child ready to start saving for his or her future college tuition, then you need to know that one of the best ways to do this is to open a 529 plan. A 529 college savings plan is a special type of a bank account created specifically for saving money for a child’s college tuition. Traditional 529 college savings plans have their advantages and disadvantages, but financial experts still consider these plans some of the best options for college tuition savings.
Advantages of a 529 college savings plan
One of the biggest advantages of saving money for your child’s college in a 529 plan is that you won’t need to pay a federal income tax on the earnings on the money in the account when you withdraw them later. A 529 plan is similar to Roth IRA in this way. There are also some other tax deductions and incentives offered by different states for 529 plans. Another pro of a 529 plan is that other people, such as your friends and relatives, can also contribute to the savings in the account, which gives you a great opportunity to ask your friends and family to forego birthday gifts for the first few years of your child’s life and instead contribute to their college savings fund. Finally, when you save money in a 529 plan, it is classified as a parental asset when your child applies for financial aid, so the savings won’t have much of a negative impact on the financial aid prospects.
The cons of a 529 plan
While a 529 plan has undeniable advantages, there are also some disadvantages that come with saving money using this plan. First of all, if you need to withdraw money from the account early, you will need to pay an income tax on it and you’ll also have to forfeit 10% of the money as an early withdrawal penalty. Another disadvantage of 529 plans is that they are quite limited in terms of how you can invest the money, so if you’re an avid investor, you may find the amount of investment control lacking. Finally, 529 plans don’t guarantee the level of your returns, so there’s a certain amount of risk involved.
How to choose a 529 plan?
Most people choose to open a 529 plan in their state, but you don’t have to do it this way. As mentioned previously, different states have varying tax incentives and conditions for 529 plans and some states even offer tax breaks and exemptions for out-of-state investors. Before you choose a 529 plan in a state other than your own, make sure to do your research and find the option with the best tax benefits. At the same time, make sure to keep an eye on fees for different transactions - some accounts have no fees at all, while in others the fees can quickly add up to a significant amount of money.