With college tuition at public and private colleges and universities seemingly on the rise every year, saving for your children’s higher education can feel like a daunting task. When your children are young, you may feel like you have plenty of time, but with some schools’ total costs currently above $40,000 per year, and some nearing $50,000 per year, it is never too early to begin saving. One of the best ways to help save for a child’s college education is through a 529 Plan (529).
Background
A529 is an education savings plan typically offered by states to provide families and individuals a tax-advantaged way to help save for higher education expenses. All 50 states offer at least one 529, and regardless of the state in which you reside, you may enroll in any state’s 529. Also, there is no limitation as to where a student may attend college. In other words, you could be a resident of Texas, enroll in a South Dakota 529 and the student may attend college in Florida. All 529s have different rules, requirements and benefits, and in most cases, your own state’s 529 will typically serve you well. However, it is always up to you to determine which plan will be best based upon your circumstances and goals.
Opening and Owning an Account
Any person may open a 529 for any beneficiary—the beneficiary does not have to be a relative. The person who opens the account is the owner of the account and has complete control of the account assets. As owner of the account, you stay in control of the money and, with limited exceptions, the named beneficiary of the account has no right to the funds. An owner of a 529 may change beneficiaries at any time. As owner of the 529, you are able to determine if and when withdrawals are taken and for what purposes. Additionally, you would be able to reclaim the funds for yourself at any time, should circumstances change and you no longer need, or wish, to pay for higher education expenses.
One word of caution is that should you have to exercise this right, it would constitute a non-qualified distribution and would be subject to income tax and penalty. Since tax was already paid on the original contributions, income tax is only assessed on any earnings that are withdrawn in a non-qualified distribution. Additionally, the penalty is assessed only on earnings in each distribution. To avoid (or at least defer) any potential penalty and income tax, you could change the beneficiary of the account to another individual who may utilize the funds for higher education expenses in the future.
The bottom line is that while you may incur income tax and a penalty on non-qualified distributions, you can still access the money (should you need or want to do so) and the owner of the account still maintains the ability to decide whether to ultimately use the money for another purpose.
Most accounts have a number of investment options from which the owner may choose. These investment options range from very conservative money market accounts, to more aggressive options, to age-dependent investments that automatically and gradually grow more conservative as the beneficiary nears college age. So, you may choose to risk the account assets in order to try and obtain more substantial growth, or you may put the assets into a more conservative investment option in order to help ensure the money is there when you need it.
Tax Issues
A 529 provides substantial tax benefits. Contributions to a 529 are made with “after-tax” money and are not deductible on your federal tax return. However, the money grows taxdeferred and as long as the money is withdrawn to pay for expenses related to higher education (e.g., tuition, books, room and board, etc.), the money is distributed to the beneficiary income tax free. In other words, neither the owner nor the beneficiary of the 529 will have to pay income tax when money is withdrawn, provided it goes toward higher education expenses and, consequently, all gains avoid taxation.
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