529 Savings Plan For Baby?
What's a 529 savings plan, and does my child need one?
Have you checked out college tuition these days? The numbers are staggering—some experts estimate that it will cost $300,000 to $590,000 to send today’s newborns to college in 18 years. So it’s a good idea to get serious about saving for baby’s education.
Among your options are 529s, which are savings plans operated by a state or educational institution and are a tax-advantaged way for parents to sock away money for their child’s college tuition. You can get one through a financial adviser.
Why get one
They’re tax-free. “The biggest single selling point of a 529 plan is that earnings grow tax-deferred, which means that you pay no taxes on earnings while they accrue in the account,” explains Andrea Feirstein, managing director of AKF Consulting Group, a strategic adviser to 529 plans. “And earnings are completely tax-free when withdrawn, as long as the funds are used for qualified higher-education expenses.” (That said, if you withdraw the money for other reasons, you’ll have to pay taxes on it and most likely cough up extra for a penalty fee.)
They’re adaptable. Besides their attractive tax perks, 529s also offer lots of flexibility. For example, you can change the beneficiary to someone else in the family (which could come in handy if your oldest decides to forgo college for Hollywood!). You can also transfer funds from one 529 to another or revise which of the mutual-fund-type investments to put your money in. Plus, you’re able to use the money you set aside at any eligible institution, regardless of which state plan you choose, Feirstein says. “An ‘eligible educational institution’ is any school that qualifies for financial aid,” she adds. This includes two-year, four-year and community colleges, graduate and professional schools, and even some schools abroad. (To figure out whether a school qualifies, check out FAFSA.ed.gov)
There are two kinds of 529s—savings plans and prepaid plans—and each has selling points and drawbacks.
Savings plan. Savings plans are offered by 48 states and Washington, DC, and are kind of like a 401(k) but for higher education, Feirstein explains. “The funds you ultimately have in your account depend upon the investment choices you make, and you can use those funds for a wide range of qualified higher-education expenses, including tuition and mandatory fees, certain room and board costs, and books and supplies required for attendance.” Anyone can open a 529 savings account, regardless of where you live or where your child attends college.
Prepaid plan. With prepaid plans, on the other hand, you’re buying a certain amount of future tuition credits at or near today’s prices. “In this way, regardless of the actual tuition cost when your student attends college, you should still receive the fixed amount of tuition you purchased.” Prepaids often come with residency requirements and are currently available in 11 states, and through a separate plan offered by a consortium of private colleges and universities.
What to consider
As you can probably imagine, you’ll have to consider a number of factors before deciding which plan is right for your family.
What your state offers. If the state in which you live or pay taxes offers a 529 plan, explore it before anything else. That way, you can take full advantage of all the state benefits available only through that plan, Feirstein says.
Your existing investment company. Next, think about whether you have a favorite fund company that offers a 529 plan on behalf of a state. “This also means that a parent should consider diversifying exposure to any one fund company,” she says. “For example, if all your retirement accounts are invested with one firm, you might want to choose a 529 plan run by another fund manager to avoid ‘putting all your eggs in one basket.’”
Hiring a pro. If you’re feeling overwhelmed—and it’s totally understandable if you are—you can always get professional help. It’ll probably cost you more than investing directly with a state, but in exchange, you’ll get trusted advice from a financial expert. (For more general info, visit CollegeSavings.org or CollegeSavingsChillOut.com)
Use your name. Regardless of which plan you choose, Feirstein stresses that a parent should always open the account in his or her name rather than the child’s. Why? “If the child ‘owns’ the account, the parent can’t change the beneficiary if the child’s plans change,” she says. “Additionally, when the parent owns the account, a small percentage—approximately 5.6 percent—of the value of the account is included in the Expected Family Contribution (EFC) for financial-aid purposes. If the child owns the account, then 20 percent of its value is included in the EFC. The greater the EFC, the lower the financial aid ultimately offered to a child.”
Transfer money with every paycheck. Once you’ve enrolled in a 529 plan, get into the habit of adding money to it regularly, even if it’s just a small amount. “It imposes discipline and helps you avoid the pitfalls of trying to time the market for your investments,” Feirstein says.
Update investments often. Check in regularly on your account to make sure you’re comfortable with the investment choices and are getting the most out of any changes to state or federal laws that affect your investment.
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