How to Start a College Savings Account
State 529 Plans Offer Easy, Affordable Way to Save for Education
Sep 5, 2008
The best way to save for a son or daughter’s college education is with a tax-advantaged investment known as a 529 plan.
These state administered investment plans are similar to 401K mutual funds and encourage saving for the future education expenses of a child or grandchild. Anyone can start a 529 plan, and anyone can contribute to one that’s been started for a child.
Withdrawals for qualified education expenses are free from federal and state income tax and many states offer other benefits, such as a tax deduction on contributions, matching funds and scholarship opportunities.
Choosing a 529 Plan
Nearly every state offers a 529 plan and most allow investors from out of state. To take advantage of additional benefits such as tax deductions, however, investors should invest in plans offered by their state of residence.
States can offer multiple plans and many can vary in the amount of fees charged and the types of investment plans offered. Many states offer age-based portfolios, so the money goes into more conservative choices the closer a child gets to the age of 18.
Some of the lowest cost plans are offered by the states of Iowa, Utah and New York, and these are worth investigating. The advantages of investing in a state of residence, however, usually outweigh the advantages of investing out-of-state.
The College Savings Plans Network, created by state treasurers, is the best way to investigate and compare state plans.
How 529 Plans Work
Starting a 529 plan is relatively easy and there is little need for an investment broker or accountant. In fact, purchasing a plan through an intermediary can result in higher than necessary commissions.
Most plans can be started through a state’s Web site. Contributions can be made via electronic transfers or by checks mailed into the plan’s administrator. Increasingly, employers are offering automatic payroll deductions to make saving simple.
There are two types of 529 plans: prepaid tuition and savings.
A prepaid tuition plan is less common. Usually sponsored by a state or higher education institution, it allows for the pre-purchase of tuition at today’s rates and usually adjusts based on tuition inflation.
A savings plan can only be offered by a state and is based on the market performance of a plan’s investments.
If a child doesn’t need the money, the account can be transferred to any other child and spent tax free on eligible education expenses. If a child earns a full scholarship, the 529 funds can be withdrawn to use for anything and tax is only required to be paid on the earnings.
If a child doesn’t go to college and the money is taken out for personal use, tax will be due on the earnings plus a 10 percent penalty.
When to Start Saving for College
There are two schools of thought about when to start a college savings plan for a child. Some argue, correctly, that the sooner an investment plan is started in a child’s life, the larger the fund that will be available for college.
Others, however, say its unwise for parents to begin a college savings account until they are able to save the maximum the law allows for their own retirement. College, after all, can be paid for with scholarships, grants and school loans.
Each individual investor must decide what is best for his or her own family situation.
