College savings plans spread the savings out over years.
College savings plans, authorized under Section 529 of the Internal Revenue Service tax code, allow families to save for future higher education cost. One or both of the two types of plans are sponsored by each of the fifty states, the District of Columbia and some private college and universities. Prepaid tuition plans allow families to purchase educational units and choose their payment plans. Savings plans have fewer restrictions, but more risk as investment accounts. Understanding the pros and cons of 529 college savings plans, and how they might meet your family's needs, helps with making an informed choice.
Benefits
The rising costs of higher education make 529 college savings plans a wise choice for some families. Tax-advantaged savings plans encourage families to save for children's higher education. Spreading the expense of college out over time lessens the impact on family budgets. Saving even a little can make a huge difference over time. For instance, according to the College Savings Plans Network, a parent of a newborn child who starts saving $50 a month in an interest-bearing college savings can amass more than $21,000 in time to pay for higher education costs.
Types of 529 Plans
Families or other interested persons use prepaid tuition plans, which are also known as guaranteed savings plans, to purchase future educational units at current rates at colleges and universities. Funds are limited to use for designated beneficiaries. Savings plans, which are also called investment plans, allow participants to open college savings accounts and save money for the college education of designated beneficiaries. Savings plans differ based on the investment options, variable rates of return and the participants' savings goals.
Prepaid Tuition
Prepaid plans have residency requirements and limited enrollment periods. Most states require that owners or beneficiaries of state-sponsored prepaid plans be state residents. Most prepaid plans have beneficiary age limits and may require installment payment amounts. Many states guarantee their plans and offer matching grants and other financial benefits. Prepaid tuition plans cover tuition and required fees. Some prepaid plans offer room and board options, while others allow excess funds to be used for qualifying expenses.
Savings Plan
College savings plans, which may only be sponsored by states, have open enrollment all year. Contributions to savings plan do not provide a lock on future education costs. Savings plans that invest in mutual funds are not state-guaranteed or federally insured. Savings plans do not have residency requirements or age limits for beneficiaries. Savings plans limit contributions over $200,000 and limit investment options. Most savings plans allow account-holders to use funds at any college or university for tuition and other education expenses, including room, board, fees and books.
Tax Considerations
Many states offer tax benefits to owners of 529 college savings plans. Some states offer tax benefits to residents only on plans within their state and a very few offer tax benefits to their residents for plans of any state. Earnings on 529 college savings plans are not subject to federal or most state taxes if withdrawals are used for eligible education expenses. Withdrawals that are not used for education expenses are taxable and subject to a 10 percent federal tax penalty on the earnings. College savings plans that invest in mutual funds are not guaranteed by states or federally insured.
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