What is a 529 Savings Plan?

If you’re thinking about saving for your child’s education early, then you may be wondering about a 529 savings plan. These types of plans are designed to help people pay for education. Before you search for a savings plan that meets your needs and goals, know how these plans work and what you can do to take advantage of one.

Saving for College

A qualified tuition plan, which is the legal term for 529 savings accounts, is a “tax-advantaged savings plan” designed to encourage saving for future college costs” according to the U.S. Securities and Exchange Commission. The number 529 refers to the portion of the U.S. tax code that authorizes their use. Two kinds of qualified tuition plans exist: prepaid and college savings. Prepaid plans are being phased out because their disadvantages outweigh their advantages. College savings plans act like other types of investments in that the money you contribute is invested on an age-dependent scheme. The older the beneficiary gets to the payout date, the more conservative your investments will become.

Anyone can take advantage of a college savings plan. Many parents open up accounts when their children are very young, and some states offer incentives for opening an account right from birth. Qualified tuition plans cover the cost of tuition, school fees, room and board, and certain school supplies as long as they’re required for attendance. While you are able to withdraw money from a 529 account to pay for non-education expenses, you’ll be charged a penalty depending on the amount withdrawn and the type of plan.

Features of a College Savings Plan

While prepaid plans are being phased out, you can still find them. However, there are several drawbacks when compared against a college savings plan.

Prepaid plans typically require that the beneficiary or owner of the plan live in the state in which they’re purchased. They also have age restrictions, and you can’t use the money for anything other than tuition and fees. College savings plans, on the other hand, allow you to use the money for any school-related expense as long as it’s necessary. Anyone older than 18 can invest, and there’s no residency requirement.

The downsides to college savings plans are that they aren’t guaranteed by the state, there’s no lock on college costs in the future and there are contribution limits that vary by state.

Other Considerations to Keep in Mind

A 529 savings plan is “tax advantaged,” which means that as long as you use the money for college expenses, withdrawals aren’t taxed. Some states also offer tax incentives for investing in qualified tuition plans, but the rules and procedures vary on location and the type of plan that you buy. U.S. News and World Report offers a complete guide on 529 college savings plans that outlines the various fees you can expect and how some states handle taxation. When you’re buying a plan, familiarize yourself with the fee structure so that you can maximize your investment.

As tuition rates continue to soar, it’s important to think about how you’re going to pay for school, especially if you have kids or want to help a family member offset the cost. There are risks associated with a 529 savings plan, but this type of investment can help you get a jump start on saving for school.