With the rising cost of college tuition, many people look for ways to save for their children’s or grandchildren’s higher education early in the child’s life. Because there are so many savings vehicles for college, it is important to look at each of the plans separately to understand their advantages and disadvantages. There are two types of 529 plans, prepaid plans and savings plans.
Prepaid plans allow the donor to purchase credits towards college at today’s rates. This means that the performance of the account relies on the inflation rates of college tuition. Not all states offer prepaid plans. States or higher learning institutions may administer the plan.
The performance of a savings plan account relies on the underlying investments in the account. These investments are usually mutual funds and oftentimes become more conservative the older the child gets. Only states can issue savings plans.
While there are many advantages of a 529 plan, perhaps the largest advantage is that the funds invested in the plan grow tax deferred until withdrawal. If used for qualified education purposes for the beneficiary, the distributions are exempt from tax. Contributions in many states are deductible or partially deductible from the donor’s income taxes. In addition to tax advantages, the donor remains in control of the account. The donor at any time can rescind the decision to give the money or can transfer the funds to another beneficiary. 529 plans are typically very easy to set up and are managed by the fund manager or a brokerage firm.
529 plans do have some disadvantages. While the donor retains control over the account, if the distributions are used for anything other than qualified higher education purposes, the donor will be subject to income tax and a 10% penalty on the gains. Another disadvantage to a 529 plan are the fees. While many plans offered have low fees, there are some that charge a higher management fee. It is important to understand each fee the plan charges as this will reduce the amount of the investment.
As always, if you are considering investing in any type of college savings plan, we recommend meeting with a qualified advisor to discuss your specific goals and needs.
For more information on 529 plans visit: https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html