Saving for College: What is a 529 Plan?

In 18 years, you can expect a four-year college degree to cost as much as $80,000 to $200,000. How can you ever save that much for your children's education? One way to start saving is with a 529 plan. The key is to start as early as possible and save as much as you can afford. So what is a 529 plan?

A 529 college savings plan is so named after section 529 of the Internal Revenue Code that allows states, state agencies or educational institutions to sponsor these tax free savings plans. There are two types of 529 savings plans, the college savings plan and the prepaid tuition plan. While both plans are different they have many advantages in common.

Both 529 plans offer federal tax savings. The money you invest in the plan grows tax free and can be withdrawn tax free when the money is used for qualifying educational expenses. There may also be tax benefits from your state as well. Check with your accountant or tax adviser for information about your state.

There are other advantages to the 529 plans besides the tax savings. Grandparents and even others that are not family can choose to contribute to your child's 529 savings plan. The contribution by others qualifies for the annual gift tax exclusion. You can transfer your savings in a 529 plan to another beneficiary tax free as long as the new beneficiary is a family member of the original.

You are convinced that a 529 plan would work for you but which type is best for you. That is a question that is best left to your financial adviser. It will also be dependent on just what types of plans are offered in your state. Since 529 plans are not regulated by the federal government many different plans exist in all 50 states.

The two types of plans are quite different so let me give you a rundown of the benefits of each plan.

The 529 College Savings Plan is open to all ages to allow saving for college expenses. A college savings plan provides a way to save money to use for education expenses. The qualifying expenses this money can be used for are: tuition, fees, books, equipment such as a computer, and room and board. There are no guarantees with this type of plan; your profits are dependent on the ups and downs of the market. There are also no residency requirements for this type of plan. This allows you to purchase a plan from another state that you are not a resident of. Think of this plan as working quite similar to many tax deferred retirement plans.

The other type of 529 plans is the Prepaid Tuition Plan. With the prepaid tuition plan you can lock in a tuition price in advance. This plan offers a margin of safety as there is no risk to the principle amount of your investment. The plan offers a more attractive rate than savings accounts and CD's. With most prepaid tuition plans the qualifying expenses only cover tuition and fees. Most state plans also have a residency requirement and have a limited enrollment period. While this plan is a bit more restrictive, it may be just right for the investor that can afford less risk than is involved with the college savings plan.

Get started as early as you can with one of these savings plans. Look to your financial adviser or a trusted broker to help you choose the plan that is right for you. Invest as much as you can. Talk to grandparents or others with an interest in your child's education. They may want to make contributions for tax savings as well. Do not fear if you cannot save enough to pay for all of your child's education, the balance can be made up with student loans or scholarships. With advanced planning you can save for your children's future and enjoy tax savings.