You may have talked with your friends about the daunting prospect of saving for your children's college education. Prices at colleges and universities have risen dramatically over the years and the increases show no signs of slowing. But we know it's worth the scrimping and saving--if your child has a college degree, she will earn on average 60 percent more per year than a person with only a high school diploma. The confidence and knowledge your child will gain at college will pay off big in the long-run.
Making plans to start saving for college now is a wise decision. The longer you save, the more your money will grow. While there are many ways to save for college, you may want to consider a 529 savings plan. Named after Section 529 of the Internal Revenue Code, these "qualified tuition plans" are designed to help parents save or invest money that will be used exclusively for college expenses. 529 plans are sponsored by states, state agencies, educational institutions, or groups of private colleges and universities.
The Scoop on Pre-Paid Tuition Plans
One type of 529 plan is pre-paid tuition in which parents purchase units of tuition in advance over time. When your child is ready to enter college, these units are redeemable at participating in-state public colleges or universities for either tuition or both tuition and room and board.
As these plans are state-sponsored, they have state residency requirements and are often redeemable only at state institutions. However, depending on the type of plan you choose, you may be able to convert your earned units to out-of-state colleges or for private colleges. Many state governments guarantee investments in pre-paid tuition plans.
College Savings Plans Can Work for You
The other major type of 529 plan is the college savings plan. This plan is similar to 401(k) or IRA investments in that the money you put into the fund is then taken and invested on your behalf. You may invest in stock mutual funds, bond mutual funds, money market funds, and (sometimes) CDs. Some investments are age-based, which means they become more conservative as your child gets closer to college enrollment.
Geared specifically for parents who think long-term and start early, college savings plans lets your money grow over many years. But remember, like all investments, there is the risk that your account may lose money and your savings may decline. Withdrawals of savings and profits from this fund must be used only for college education.
Tax Benefits with 529 Savings Plans
Many states offer tax deductions on your contributions into the plan, income exemption on withdrawals, and matching grants for the amount you place in a 529 plan. Some states require residency for these benefits, while others allow you to invest in their state 529 plan while living elsewhere. It's worth the time to compare the policies of various states to see which will provide a net gain. If you move money from one state plan to another, you may incur tax penalties.
While your contributions are not deductible, your earnings are not subject to federal income tax, provided the withdrawals are used for college expenses. In fact, if you use the money for something other than college, you are subject to a 10 percent federal tax penalty on the earnings.
Fees for 529 Plans
Here comes the rub. As with nearly all investment products, there will be fees, fees, and more fees, collected by the states, educational institutions and brokers. Pre-paid tuition plans charge enrollment and administrative fees. College savings plans may have any combination of enrollment, annual maintenance, asset management, annual distribution, sales, broker, and load fees. Plans sold directly from the sponsoring state or institution lack expensive broker fees.
Another benefit of starting a 529 plan early for your child is that annual fees and load fees are higher when there are only a few years between when you start the plan and when your child withdraws it for college expenses.
Read More about the 529 and Its Benefits
Be sure to read all plans in detail before selecting the one that's right for you. The College Savings Plans Network, an affiliate of the National Association of State Treasurers, offers detailed information on most of the available 529 plans so you can compare plans from around the country. You'll be glad you invested early -- they grow up so fast!