How the 529 Plan can Help Your Family Save for College

Investing

Not sure which college savings plan is right for you?  See also NerdWallet’s Best 529 Savings Plans of 2013.

By James Sallery

A college education is expensive. In today’s tough economic climate, more and more families are shying away from the economic commitment required to send family members away for a first-rate education. However, whilst the large overall cost might be daunting for many low-to-middle income families, it’s an investment that usually pays off – the earning potential for a college graduate can dramatically outshine those without degrees. In saying that, the prospect of being in-debt for decades can still be off-putting for many potential students and their families, even if earnings see a spike after graduation. Thankfully, the 529 plan can make a difference.

The 529 plan acts to help families save for future college education costs – and it has specific tax benefits when compared to normal savings accounts. Also known as a “pre qualified tuition program”, the 529 plan was launched in 1996 under the Small Business Protection Act, as a way for families to save for future education expenses.

One of the main advantages of the 529 plan is it’s tax status. Earnings are accumulated under a tax-deferred status and any educational expense distributions are tax free. The plan is normally operated by an individual state or educational institution, but your prospects for saving are not limited to in-state organizations, although various plans can differ from state to state.

There are two main types of 529 plans: A savings plan and prepaid plan. Although both carry tax benefits that are aimed at achieving the same goal – saving for college – they operate in a slightly different manner. Saving plans are similar to 401k or IRA plans in that they invest your money into mutual funds in an attempt to grow the investment. The plan will offer you some specific options as to where you want your contributions to be invested, but they carry a risk as your account could go up or down depending on the performance of the investment.

Pre-paid plans allow you to pay the future cost of education up-front over a number of years. Pre-paid plans are normally put in place for in-state colleges but can be converted for private or out-of-state use at a later date.

Both plans aim to fund tuition costs at higher-educational institutions, whilst some plans will also cover other implied costs of a university education such as board, fees, books and other living costs. Whilst the upside and potential gain available from a savings account is much higher, there’s also a higher amount of risk involved. Pre-paid plans have more specific limits as to who can enrol into such a plan, but savings will be guaranteed and backed by the state.

Not only has the advent of the 529 plan allowed countless families to put money aside for college in a planned and regulated manner, but it has also offered them a range of financial benefits in doing so. For any family planning to send relatives to college, the 529 plan should be considered as a way of gaining specific tax benefits on the worthwhile cost of a college education.

 

Disclaimer: This article is a part of NerdWallet’s series of user perspectives on 529 Plans.  The views and recommendations in this piece are held by the individual contributor and do not necessarily reflect the opinions of NerdWallet as a whole.