Contributions to a 529 Plan
The numbers can be daunting. The average total cost of sending a student to college, including in-state tuition, fees and room and board, was $14,333 in the 2008-09 school year. That's 5.7 percent more than it cost the year before. Starting a 529 plan when the child is young can help you save for college and possibly give you a break on your state income taxes.
Identification
A 529 plan is a tax-advantaged investment vehicle meant to encourage parents to save for their children's college educations. It's named after the section of the Internal Revenue Code that established the plan in 1996.
There are two types of 529 plans: savings plans and pre-paid tuition plans. Contributions to savings plans are invested, typically in mutual funds, with the hope that the return rate will outpace inflation and the rising costs of college. Prepaid tuition plans allow parents to pay for future tuition at today's prices. The Independent 529 Plan is a prepaid tuition plan sponsored by certain private colleges.
Federal Taxes
The advantage of using a 529 savings plan to save for college is that the earnings grow tax-free and as long as the funds are used to pay for costs associated with higher education, you won't pay any taxes when they're withdrawn. However, there is no federal tax deduction for contributions contributed to these plans. Contributions are made with after-tax dollars.
State Taxes
Each state sponsors at least one 529 plan, but you don't have to go to college in the state that sponsors your plan. Most states allow you to use the funds at colleges nationwide.
Unlike the federal government, some states do offer tax incentives for contributing to a 529 plan. In addition to the earnings being tax-free if they're used to pay for college expenses, some states also offer an upfront deduction for contributions. Some states require that the contribution be made to that state's plan for it to be deductible, but not all states have that requirement.
Examples
Connecticut allows a deduction of up to $5,000 a year for an individual and up to $10,000 a year for a married couple filing jointly for contributions to the Connecticut 529 plan, Meanwhile, contributions to any 529 plan up to $750 per year for an individual and up to $1,500 per year for a married couple filing jointly are deductible when computing Arizona state taxes.
Other states, such as Colorado and New Jersey, do not allow for any deductions.
Considerations
Do your research before deciding on a 529 plan. Not only do the tax implications and other factors vary by state, but there are also several other aspects to consider, including fees, investment options and the stability of the program. Most plans are available directly from the sponsor, so you can avoid paying broker fees-and have more money to invest-by establishing the plan and setting up the contributions yourself.
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