For families trying to save for their children’s college education, 529 college savings plans, named for a section of the tax code, have always been hailed as a great option — perhaps the best. Let’s look more closely at what has always made them a good deal:
- Families invest through these accounts without earnings being taxed as long as the funds are used to pay for college expenses.
- Earnings have been typically free from federal and state taxes.
- Grandparents, aunts, uncles and anyone else who cares can contribute to the account.
- Those that operate like a 401(k) retirement plan invest in stocks, bonds or money market funds.
Note that laws may vary from state to state, so check each plan’s particular rules.
But what about the new tax law? How does it affect 529 college savings plans? In fact, it may make them even more attractive from a tax point of view.
You cannot deduct 529 contributions on your federal tax return. But with state income taxes no longer deductible over $10,000 on federal tax returns, you want to make sure you get every dime you have coming to you. Many states allow residents a limited deduction or credit against state income taxes for contributions to state-run 529 plans.
Even if you don’t qualify for a state income tax deduction, a 529 plan is still a great way to save for college:
- All growth of investments inside the plan is withdrawn tax-free for approved college expenses, and this applies to any accredited school in any state, no matter which state plan you use to invest.
- The money can usually be transferred between members of the same family, so if a sibling gets a full-ride scholarship, it’s possible that another family member can use the 529 account.
- Assets in a 529 plan count far less against the family in the financial aid formulas than do student assets.
- Plans held by grandparents don’t count at all, but you have to be shrewd about withdrawals.
Typically, a 529 plan offers a limited number of mutual funds and the eventual results depend on market performance and your investment choices. Most plans offer age-based funds that promise to become more conservative as your child gets closer to needing the money for college.
One of the best ways to start investigating 529 plans is at www.SavingforCollege.com. You can compare the various plans for performance and fees. You can even link directly from the site to application forms for various plans. It’s worth comparing your state’s plan to those offered by other states since fees can be a drag over the long run of the investment.