With back-to-school season in full swing, you may be one of many parents with future college expenses on your mind. Between tuition, room and board, textbooks and other supplies, it’s easy to get overwhelmed by the cost of a higher education. Thankfully there are plenty of long-term savings solutions to help you ease the burden of college expenses. One such option is the 529 college savings plan but, like most financial decisions, it can be difficult to determine whether or not it’s right for you. So, to help you decide, here’s a breakdown of everything you need to know about 529 plans.
529 savings plans are investment accounts with several tax advantages, making them pretty useful when saving for college. Much like a Roth IRA, contributions to the account are taxed but any earnings made via interest accrue federal tax-free. Additionally, withdrawals from the account are also tax-free providing they’re put toward college expenses. State tax exemption varies, but some states will refrain from taxing contributions to the plan.
It’s also important to note that 529 savings plans aren’t controlled by the beneficiary. Instead, whoever opens the account is awarded control over the account. This is a great way to ensure that your savings will go toward their intended purpose.
The Pros of a 529
In addition to being tax-free and allowing you to earn interest, 529 savings plans come with an assortment of benefits. First, many offer an automatic contribution option, which allows you to deposit a specific amount of money each month from your checking or savings account. This can make staying on track to reach your savings goal a breeze. Additionally, 529 savings plans don’t have a cap on how much you can contribute each year. So unlike an IRA, you’re free to put in as much money as you wish. Finally, 529 savings plans offer a great deal of flexibility. The money can easily be transferred from state to state and benefactors can easily switch between family members (in the event one of your children decides not to attend college).
The Cons of a 529
On the downside, should you decide to not use the money you’ve saved in your 529 savings plans for college expenses, you’ll be hit with some pretty harsh penalties. Withdrawals made for non-college specific purposes are charged a 10% tax penalty and these earnings will be taxed as ordinary income (on both state and federal level). Leftover money may also be susceptible to penalties and will definitely be taxed by both the state and federal government. This can make managing 529s fairly tricky as you may want to avoid investing too much and leaving yourself vulnerable to penalties later on.
Providing you’re comfortable with handling the spending limitations, the 529 savings plan could be a great way for you to save for your child’s future college expenses. However, it’s important to remember that you may need to supplement these savings with other payment options. It tends to be a good idea to educate yourself on the various forms of student loans and the federal aid options that might be available to you and your family — and how those options might impact your finances and your credit (you can see a summary of your credit report for free on Credit.com to get an idea of where you stand). The more informed you are, the less worried you’ll be about affording college expenses.
More on Student Loans:
- A Credit Guide for College Graduates
- How to Pay for College Without Building a Mountain of Debt
- Strategies for Paying Off Student Loan Debt