Saving For Your Child’s College Tuition
With tuition rates rising faster than inflation, saving for your child’s tuition can seem like a daunting prospect. The 529 plan was instituted in 1996 by the federal government to help families with this task. The 529 plan is an educational savings plan named after section 529 of the Internal Revenue Code. Changes to federal tax laws in 2001 and made permanent in 2006 have made the 529 Plan an increasingly popular tool for parents wishing to save for their child’s college education.
The popularity of the plan comes from the favorable tax benefits associated with it. All earnings within the plan are exempt from federal and state taxes. Qualified distributions made to the beneficiary of the plan are also tax exempt. Prior to 2001 these distributions were taxed at the beneficiary’s federal income tax rate.
Contributions of up to $300,000 can be made over the life of the plan per beneficiary with annual contributions subject to federal gift and estate tax laws. Individuals can contribute up to $12,000 annually per beneficiary or as much as $60,000 if a 5 year exclusionary period is taken without being subject to the gift tax. For couples who file a joint tax return these numbers rise to $24,000 and $120,000 respectively. If the 5 year exclusion is taken and the contributor dies within this period a pro-rated amount will revert back to them and be subject to federal estate tax laws.
There are two basic types of plans, either prepaid or savings. A prepaid plan is where you are able to purchase tuition credits based on today’s rates, where the number of semester or years purchased are guaranteed despite what happens to tuition rates in the future. A prepaid plan can either be administered by a state or educational institution. Obviously it’s difficult to determine where your child will enroll in the future so the value of the plan will be determined by the future tuition rates of the institution running the plan if the beneficiary goes to another school.
The other type of plan is a savings plan where value is determined by the underlying investments of the plan. A savings plan can only be administered by state institutions. This type of fund is usually professionally run by a financial institution like a mutual fund or investment firm. They tend to invest aggressively in the earlier phase of the plan but will shift to safer investment like fixed income securities as the beneficiary approaches their college years.
It can be difficult to choose which type of plan to take. Also each state offers their own distinct plan and it is important to note that you are not restricted to choosing the plan from your state of residency although there may be additional tax benefits for doing so. Be sure to sit down with your financial advisor to determine which course of action is best for your specific situation because the sooner you start planning for your child’s future the better off you will be.
