When planning for college it is a very good idea to use the 529 college savings plan, since this plan offer you substantial tax benefits under the U.S. tax law (section 529 of the Internal Revenue Code). You can choose between two different types of college planning under section 529: The prepaid 529 college savings plan and the savings 529 college savings plan.
With a prepaid 529 college savings plan you do your college planning by purchasing tuitions credits. Since tuition credits are likely to be more expensive when you child is old enough for college, a prepaid 529 college savings plan can make the education cheaper.
The other type of 529 plan for college planning – the savings 529 college savings plan – is a way of accumulating enough money over time to pay for you child’s tuition and expenses. Even though the state is supervising the college planning 529 account, the actual administration of the 529 college savings plans are usually done by a mutual fund company.
The growth of your 529 plan will depend on the investments and the overall market performance. When you choose between different 529 college savings plans, you can pick a 529 college savings plan that is based on age. When you child is very young, the investments for the 529 college savings plan will be more risky but also potentially more rewarding. As your child grows older, the college planning investments for the 529 plan will become more and more conservative and when you child is almost old enough for college the money will be invested in very safe assets. It is naturally very important the value of the 529 plan to not plummet the same year as you child begins college.
You can also choose a form of 529 college planning where the underlying investments for the plan will keep the same equity-to-fixed-income ratio all the time. These types of 529 college planning will not be affected by the age of your child. It is common for mutual fund companies to offer 529 plans with a guarantee. You can for instance choose a 529 plan where the principal is protected. The value of this type of 529 college savings plan can never drop below you initial purchase value.
As mentioned earlier, college planning will be linked to substantial tax benefits if you choose a 529 college savings plans. Since the state wish to encourage college planning, the money in your 529 plan will grow completely tax free. This means that you will not pay federal nor state income tax on the accumulated values of your 529 college savings plan. Unlike some other types of tax-deferred saving accounts, the distributions from your 529 plan will also be liberated from federal taxation as long as they are used to pay for qualified higher education.
Many states will also allow you to make this type of withdrawals from your 529 college savings plan without paying any state income tax. You need to contact your specific state in order to find out how they treat withdrawals from 529 college planning accounts.
Finding a school that offers qualified higher education will not be hard, since there are more than 8,000 schools in the United States that offers education that is qualified according to the tax rules for the 529 plan. You can also choose among more than 800 foreign schools that are qualified according to the tax rules for the 529 plans. The term “education expenses” do not only refer to tuition expenses. You can use the money from your 529 plan to pay for housing, literature and other types of expenses linked to qualified higher education.
The contribution limits for 529 plans are high and you can easily change the beneficiary, e.g. when one of you children has finished college and you need the money to pay for the higher education of a younger child. You can also use the 529 for estate planning, since you can contribute up to $110,000 immediately if you are a married couple filing jointly and refrain from doing any additional contributions during the next five years.
The current status of the 529 college planning account was introduced by the Economic Growth and Tax Relief Reconciliation Act of 2001. Earlier, the distributions from 529 college savings plans were taxed according to the beneficiary’s federal income tax rate.