While there might not be endless ways to save for college, there are certainly more than enough to warrant some hesitation before choosing which account type is most appropriate for your specific demands and goals. However, any discussion regarding saving for college must start with 529 plans given their popularity and wide range of choices.

529 Basics

529 plans, named for the section of our tax code from which they were created, are state-sponsored plans typically administered by investment or mutual fund companies. Following both federal and state-specific guidelines, 529s allow investors to save for higher education expenses – including tuition, books, and room-and-board under certain circumstances – to generate tax-free growth as long as distributions are used for qualified expenses.

Although every state sponsors their own plan, investors are not restricted to using the plan from their own state. However, there are some states that offer tax benefits on contributions so it’s always best to consult with your financial professional to fully understand the details of the different plans.

529 Plans Shine for Younger Children

Given their ability to use investments rather than cash-based instruments for growth, investors with longer time horizons can take advantage of stock and bond-based mutual funds within most 529 plans to maximize long-term growth. In other words, the younger the child, the more risk can be absorbed to leverage market growth.

When a Child No Longer Needs the 529 for College Expenses

One of the more common questions regarding 529 plans concerns funded accounts without beneficiaries if a child chooses not to go to college or receives a scholarship. Regarding the former of the two, if a child chooses not to go to college, a 529 plan can be transferred both tax and penalty free to another beneficiary as long as they are within the immediate family. If there is no one to transfer the account to, the growth portion of any non-qualified distributions will be subject to income tax and penalties.

In the case of scholarships, if your child does not need the assets within the 529 plan to pay for tuition and no other eligible beneficiaries are available, the amount of distributions allotted to growth will be taxed but not penalized. Of course, given the fluid nature of our tax code, it’s always in your best interest to consult a tax professional before taking any distributions.

Determine What You Are Saving For

Many times, parents are looking for accounts that can be used to save for college as well as anything else. If that is the case, a 529 plan might not be a good fit given its restrictions on qualified distributions. However, an IRA – most commonly a Roth IRA due to its tax free growth  – can be used to save for both retirement and college tuition if used in a particular fashion. The IRS allows IRA owners to take distributions on accounts without penalty – even before the age of 59 1/2 – if such distributions go directly towards certain college expenses of the owner’s child, grandchild, or spouse, and certain requirements are met.

If something even more flexible is desired, an ordinary, non-qualified investment account can be used to save for nearly anything – college included – but lacks the tax advantages of 529s and other college-oriented accounts.

 

 

4/3/2019