A post from Heather C., our CMF Finance Coach:
Peanut butter and jelly or chicken nuggets? Playground or bouncy house? Contribute to a 529 plan or not? As a parent, you’re plagued by these weighty issues daily. So what to do? Here’s my take: chicken nuggets, playground and well, maybe. Read on to find out a little more about these complicated college savings plans.
What are they?
529 plans are state savings plans intended to help set aside money for future college costs. There are two main types of plans: (1) prepaid tuition plans and (2) college savings plans. Nearly all states offer some type of 529 plan.
How do they work?
Prepaid plans allow you to prepay and lock in costs for participating colleges and universities (often in-state, public institutions).
College savings plans allow you to invest in mutual funds or other similar investments that are designated for the beneficiary’s future college expenses.
We’ll focus more on the North Carolina college savings plan, but keep in mind that prepaid plans are an option, and you can invest in any state’s savings plan regardless of where you live or where your child ends up going to college.
What are the advantages?
– North Carolina’s 529 savings plan allows state residents the following contribution deductions from their state income taxes: $2500 for individuals; $5000 for married filing jointly.
– You won’t pay state taxes on earnings as long as you’re a North Carolina resident and you use the money for Qualified Higher Education Expenses (tuition, room & board, books, etc).
– You won’t pay federal taxes on your earnings.
– Anyone can open an account for your child, and anyone can contribute to a plan you set up. So go ahead and hit grandma and grandpa up for some college money for your kids. Your four-year-old will appreciate it way more than that new Transformer.
– Investment minimums are low. You can start a plan for as little as $25. On the flip side, you may contribute very large amounts each year should you choose to do so.
– If your child doesn’t end up going to college, you may change the plan beneficiary to another member of the family.
– Prepaid plans lock in costs, so you don’t need to worry about tuition increasing by the time your child goes to college.
What are the disadvantages or limitations?
– Contributions to a 529 plan are not deductible on your federal return.
– State deductions are subject to various limitations and residency requirements. Some states offer no deduction at all, and some plans only offer deductions to whomever opened the account.
– College savings plans are subject to market volatility, and your investment may lose money.
– If your child doesn’t go to college and you don’t have another family member to designate as the new beneficiary, you’ll pay taxes anda 10% penalty on your refund.
– Some plan maintenance fees can be high. When shopping for a plan, look for fees that are less than 1%.
– The institution must be considered “eligible,” so check with the US Department of Education before you begin.
– 529 plans can impact a student’s eligibility for financial aid, especially if the plan is owned by a student who is no longer a dependent on his parents’ tax return.
Conclusion
As a parent, you’re probably used to putting your child’s needs before your own. However, retirement plans such as 401Ks and Roth IRAs often offer more advantages than 529 plans. Not to mention, you can borrow for college, but not for retirement.
If you don’t have a retirement plan set up for yourself, now is probably not the time to set up a 529 plan. If you do have a retirement plan and are actively contributing to it – preferably maximizing it – then you might want to consider a 529 plan. Just remember to choose your plan wisely and be sure you fully understand the limitations as well as the advantages of 529 plans.
And it’s always a good idea to consult a professional before choosing chicken nuggets, or for that matter, setting up a 529 plan.
Heather Cellini
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Have a comment or question for Heather? She’ll be checking our comments and will answer any questions you have! Oh, and if you haven’t already, I featured Heather’s playgroup on MomsCharlotte.com on Monday hop on over and say hi there too!
Heather good article, here is a great book for families on College Savings the 529Guru at Savingforcollege.com is making available
for a limited time for free download.
http://www.savingforcollege.com/529-day/