A college savings plan, also called a 529 plan account, is an investment account you open that can contain a wide variety of investments. While in many ways it’s similar to an account you’d open for any kind of investing, it has several unique characteristics.
It Grows Federal Income Tax Free
As long as you use the money for a qualified education expense, you won’t have to pay taxes on interest earned or when stock value increases. If you invested this money in a traditional investment account, you’d more than likely pay capital gains tax.
It Has a Specific Beneficiary Listed
You, the parent, will own the account, but you will list someone else or yourself as the beneficiary who will use the funds for their education. For instance, if you’re saving for your children’s education you will have to pick one name to benefit from the account. You can change the beneficiary, but unless your children are more than four years apart, you should open separate accounts for each child. If you decide to use unused funds for your own education, you can change the beneficiary to yourself, your spouse, or anyone else you choose.
It Can Take as Little as a Penny to Start a Plan
Each state or plan has different rules for how high your initial deposit should be. It can be as little as a penny to $25 in some states, or more in other states. There are management fees, which are generally a percentage of your account balance or a set amount, such as $10 charged to manage your account. Thus, you wouldn’t want to only keep a penny in your account, but it’s always good to know what the deposit requirements are.
You Can Choose An Age-Based Investment Option
Investment choices are can be limited in 529 plans. You can’t choose individual stocks, and each plan has a limited selection of mutual funds to choose from. But, the most popular option is a good one: age-based investments. These options give you a choice of portfolios that gradually get less risky as your child approaches college age. Risk is decreased by the manager selling more of your investments that are dependent on the stock market in favor of savings accounts and short-term bonds.
You Don’t Have to Choose Your Own State’s Plan, but Should if Doing so is Tied to Tax Benefits
Every state has its own 529 plans, but you can pick a plan from any state. The main benefit to choosing your own state’s plan is if your state offers a state income tax benefit, or has a matching grants program for your contribution. Being able to deduct your 529 plan contribution could add hundreds to the money available to you for saving for college. For instance, let’s say you contributed $200 per month for your children’s college educations, and your state’s income tax rate for your tax bracket is 5 percent. You’d save $120 on your taxes. If your contributions were also matched on the first $500 by your state, you’d receive another $500.
If your state doesn’t offer either benefit, then you might choose a different plan if you like the investment options better, or it has lower management fees. You can find out more about your state’s and other plans by college with the comparison tool on collegesavings.org.