Mini is finishing 3rd grade this year. In another short 9 years, she will be heading to college. I should have started her college savings yesterday, but like most PGY’s, I took care of my own student debt and retirement savings first. I’m excited to invest in my kid’s future by saving up for her college/graduate school expenses. To start saving for Mini’s college, I will set up a 529 plan for her.
We’ve always emphasized in our family the importance of education. Mini has learned to invest 95%+ of gift money for her future rather than buying toys and trinkets.
Stats like the following shows that education indeed is one of the most worthwhile investments any individual can make.
529 “qualified tuition plan”
- A tax-advantaged savings plan is designed to encourage saving for future college costs. This works very much like Roth IRA in that you contribute post-tax dollars and the principle can grow tax free and both principle and growth can be withdrawn tax free for college expenses.
- Sponsored by states, state agencies, or educational institutions.
- Authorized by Section 529 of the Internal Revenue Code.
- There are two types of 529 plans:
- pre-paid tuition plans
- college savings plans.
- All fifty states and the District of Columbia sponsor at least one type of 529 plan.
- Some private colleges and universities sponsor a pre-paid tuition plan.
Are you ready to 529?
Instead of saving for future post-secondary educational expenses (for yourself or others), you may want to first tackle other financial goals:
- paying off your own/ current educational debt, especially if it’s growing at a high interest rate
- saving for retirement, especially you are in your lower income years and can really benefit from maxing out post-tax spaces.
- buying a home
- paying off high interest credit card bills. (Hopefully as DWM-readers, you are getting paid cash back by credit card companies, rather than paying them interest)
Remember that you may face penalties or lose benefits if you do not use the money in a 529 account for higher education expenses.
If you decide that saving for college is right for you, then you can determine what college saving options to pursue:
- 529 plan
- Coverdell education savings accounts
- Uniform Gifts to Minors Act (“UGMA”) accounts
- Uniform Transfers to Minors Act (“UTMA”) accounts
- tax-exempt municipal securities, and savings bonds
- a taxable account
Each college saving option may have a different impact on financial aid eligibility, so you should evaluate each option carefully.
If you are ready, the rest of this post gives you the 1-2-3 on 529:
529 plan effects on federal and state income taxes:
- Earnings in 529 plans are not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for eligible college expenses.
- However, you generally will have to pay income tax + an additional 10% federal tax penalty on earnings if you don’t spend the withdrawal on eligible college expenses.
- Many states offer state income tax or other benefits, such as matching grants, for investing in a 529 plan. But you may only be eligible for these benefits if you participate in a 529 plan sponsored by your state of residence.
- Just a few states allow residents to deduct contributions to any 529 plan from state income tax returns. (Arizona is one.)
- If you receive state tax benefits for investing in a 529 plan, make sure you review your plan’s offering circular before you complete a transaction, such as rolling money out of your home state’s plan into another state’s plan. Some transactions may have state tax consequences for residents of certain states.
Fees and expenses of a 529 plan:
Fees and expenses lower your returns; so know what you are paying for.
- Prepaid tuition plans typically charge enrollment and administrative fees.
- College savings plans may charge
- enrollment fees
- annual maintenance fees
- asset management fees: depend on the investment option you select.
- Some college savings plans will waive or reduce some of these fees if you:
- maintain a large account balance
- participate in an automatic contribution plan
- reside in the state sponsoring the 529 plan.
To Learn More:
529 Plans: Questions and Answers (IRS)
An Introduction to 529 Plans (U.S. SECURITIES AND EXCHANGE COMMISSION)
IRS Publication 970: Tax Benefits for Education
529-plan-contribution-deadlines-for-state-tax-benefits
The Experts: Are 529 Plans the Right Choice for All Families Saving to Send Their Kids to College?
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