529 Savings Plans
The most common college savings program, the 529, is a state-sponsored investment plan. You can create a 529 for anyone, including your children, a friend or even yourself! 529 Plans can be used for your choice of school in any state, and the amount that you can contribute to 529 plans depends on the plan that you choose, though most are capped around $300,000.
Although prepaid plans have many of the same benefits of 529 savings plans, prepaid plans offer one major perk—the ability to lock in today’s tuition rates. Although each state uses different methods, these state-sponsored plans allow you to lock in tuition rates for in-state public schools years before your child will actually attend them. If your child decides to go to an out-of-state school, the money will still be available for them, but they will not get the benefits of a lower tuition rate. The amount that you are allowed to contribute to these plans varies depending on the age of your child and the plan itself.
Like 529 savings and prepaid plans, Coverdells allow parents to save money for qualified school-related expenses. However, Coverdells are not state sponsored and are offered by banks, brokerage firms and mutual fund companies. Contributions are limited to $2,000 per year per child, and to contribute you must have a gross adjusted income of less than $110,000 for single filers and less than $220,000 for married couples filing jointly. If you’re wondering if you are allowed to have both a 529 and a Coverdell, the answer is yes!
What expenses are covered?
Under most 529 savings plans, qualified expenses include tuition and fees as well as costs associated with room and board.
With prepaid plans, qualified expenses are generally more limited and usually include tuition only.
Coverdells offer the broadest type of coverage when it comes to qualified expenses. Not only do these savings plans allow investments to be spent on tuition, fees, and room and board, but they also cover certain supplies and can even be used for private schools below college level. If you’re looking to save some money to send your child to a private elementary school or high school, this may be the plan for you.
What are the tax benefits?
Although most people know that college savings plans offer tax benefits, you may be surprised to learn just how exceptional these benefits are! All three plans allow your investment to grow tax-deferred, and withdrawals used to pay for qualified expenses come out federally tax-free! Depending on the state you live in, you may also receive additional benefits such as upfront deductions for your contributions.
Who controls the account?
Although regulations can vary from state to state, in most states, both 529 savings plans and 529 prepaid plans always remain under the control of the contributor. However, with Coverdells, the account assets become property of the student when they turn 18, which can be a negative factor if you worry that your child may not be completely responsible with money.
Is there a penalty for using expenses on non-qualified items?
Although we all wish items such as new cars or appliances for your child’s dorm room were qualified expenses under a college savings plan, unfortunately, they are not. Under all three plans, if you decide that you’re going to take some cash out for expenses other than those outlined in your plan’s contract, you will be hit with a 10% penalty as well as the withdrawal being taxed as regular income.
How do I find a plan?
If you’ve decided to go with a Coverdell, nearly all banks and brokerage firms offer these plans. Many companies such as Capitol One, E-Trade and TD Ameritrade require low minimum opening contributions of $1000 or less, and some don’t require a minimum deposit at all.
If you’ve decided that a 529 savings or prepaid plan is for you, the best way to start is by searching for your state-sponsored plan. Since some states offer residents perks such as tax-deductions or matching contributions, choosing your state’s plan can often yield some pretty high-value benefits. However, if you find that your state’s plan does not offer residents any additional benefits, you can begin researching the plans in other states, many of which are available to out-of-state residents. Although you may not get any additional benefits, you will have the pick of the litter and get the option of choosing the best plan for you and your family.