Saving for college can be overwhelming – the savings options alone can make your head spin! The 529 plan is arguably the most well-known college savings vehicle. This overview will give you a better understanding of the popular plan and can help you make the best savings choice for your family.

 

A 529 plan is an education savings plan that was specifically designed to help families save for higher education. Federal tax code now allows up to $10,000 a year in K-12 private school tuition as a qualified expense, so it can be used for primary education as well. Named after Section 529 of the Internal Revenue Code, 529 plans are offered by every state, and many states even offer special tax benefits to investors.

 

Money in a 529 plan grows tax-free, and there are no taxes on its distribution if it is used for qualified expenses.

 

A 529 plan doesn’t carry age or income limits, and an account can be opened with as little as $25, with subsequent contributions as small as $15. The maximum contribution amount is $370,000. Grandparents and others who contribute to a plan can deposit as much as $15,000 each without the gift being taxable.

 

The parent is the permanent account holder and will retain control of the funds. Also, 529 plans are treated as an asset of the parent, which means that your savings will have a smaller impact on federal financial aid.

 

There are two types of 529 plans: prepaid and savings. It should be noted that Texas residents are not limited to investing only in Texas’s 529 plans.

 

529 Prepaid Tuition Plan

The Texas Tuition Promise Fund is Texas’s 529 prepaid tuition plan. With this plan, contributions are used to buy tuition credits, essentially locking in a Texas public college or university education at today’s rates. The Texas Tuition Promise Fund offers three pricing levels (called “Tuition Unit Types”) to address the different needs of families.

The Texas Higher Education Coordinating Board reports that tuition costs in Texas rose 72 percent on average from 2003-2009. One argument for selecting a prepaid tuition plan is it’s extremely likely tuition costs will continue to rise. This type of plan offers an opportunity to protect against those rising tuition costs.

 

529 Savings Plan

The Texas College Savings Plan is a 529 college savings plan administered by the state of Texas. A 529 savings plan covers not only tuition and fees, but can be used to pay educational costs such as books, lab fees, and room and board. The funds may be used at any accredited public or private higher education institution worldwide.

 

Prepaid vs. Savings Plans

A 529 prepaid plan comes with no investment choices, while a 529 savings plan offers some choice. For example, the Texas College Savings Plan offers 20 different investment portfolios. There are, however, restrictions on how often your investment choices can be changed.

 

529 prepaid plan funds can be used for tuition and required fees only, while savings plan funds also cover additional, approved educational costs such as books, lab fees, and room and board.

With the 529 prepaid plan, there may be a deadline by which the tuition credits must be used. In contrast, there are no age restrictions on your investment with the 529 savings plan, so funds will be available in the future, should your child defer school.

 

Disadvantages

If you invest in a 529 prepaid plan and your child decides to attend a private or out-of-state college, your savings may not cover all your funding needs. Similarly, if you don’t invest enough into a 529 savings plan, or if your money doesn’t grow as quickly as expected, you may not have enough to cover your child’s tuition, fees and other educational costs.

 

As with most investment plans, there are fees and expenses that will be deducted from your 529 plan savings account balance or levied against your prepaid plan contributions. Withdrawals of earnings are taxable and subject to a 10 percent penalty if they aren’t used for qualified educational expenses. And there’s no guaranteed return on your investment.

 

The Bottom Line

Which savings plan to choose is a personal choice. However, it all boils down to the same thing: saving should begin early. The longer your money is invested, the more time it has to grow through regular deposits, in addition to interest and dividends earned. And while investing in a good educational savings plan can’t take away the worries that come with a child leaving the nest, it sure can help to relieve financial anxiety. So, get saving!

 

Alison Bogle is an Austin-based freelance writer and mom of three.

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