Most parents want their children to get the best higher education possible, but that dream comes with a high price tag. The growing costs of college mean parents who intend to help foot the bills need to plan, and as early as possible.
One way to save for college tuition is through a 529 college savings plan, named for the relevant section of the federal tax code.
Also known as a “qualified tuition plan ,” this is a type of tax-advantaged account that allows savings to grow through investment and funds may only be withdrawn for certain educational expenses.
While 529 plans have been around for more than 20 years, many parents still aren’t sure how they work. Yet 529 plans can be an effective way to save for your child’s education while taking advantage of tax benefits.
Here’s what you need to know about 529 plans and whether opening one is the right move for you.
529 Plan Basics
There are two kinds of 529 plans, and every state offers at least one.
Prepaid Tuition Plan
A prepaid tuition plan allows you to prepay tuition and fees at certain colleges and universities at today’s prices Such plans are usually available only at public schools and for in-state students. Only a few are accepting new applicants.
Free Application for Federal Student Aid (FAFSA®) , the account is considered an asset.
If the parent owns it, only up to 5.64% of the amount saved counts when the government calculates the “expected family contribution” in deciding on the financial aid package. (If the student owns the plan, up to 20% of the savings can count in the calculation.)
The bottom line is that while a 529 plan may slightly reduce available financial aid, it will likely save much more overall by reducing the amount of loans you or child need to take out.
If you put your college savings in an online IRA, that won’t be counted as a parental asset on the FAFSA since it’s a retirement account. The 529 plan, though, comes with more tax benefits. Specifically, you can withdraw both contributions and earnings any time from a 529 plan without paying taxes or penalties, as long as it’s for qualified educational expenses.
With a Roth IRA, you can withdraw your contributions at any time, also without taxes or penalties. But you generally must be at least age 59½ and have had the account for at least five years to withdraw earnings tax- and penalty-free.
Unlike 529 plans, you can only contribute if you fall below a certain income threshold , and there’s a limit to how much you can put in each year ($6,000 for most individuals in 2021, or $7,000 if 50 or older).
Additionally, some 529 savings plans allow you to deduct contributions on your state income taxes, while any contributions to Roth IRA accounts are with after-tax dollars.
Choosing a 529 Savings Plan
Every state offers a 529 savings plan, but not all are created equal. When trying to find the best 529 college savings plan, you may want to think about the tax benefits and the fees.
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