One of the ways parents can plan for their child’s education is to open up what is called a “529 Plan” at a local financial institution. This is a specific account used only for a child’s future education. There are two types of 529 Plans: prepaid tuition plans and college savings plans.
A pre-paid tuition plan generally allows the account holder to purchase “units” or “credits” at participating colleges and universities for future tuition (and sometimes room and board). Most pre-paid plans have residency requirements and many state government sponsored plans guarantee investments.
A college savings plan generally allows the account holder to establish an account for a student (i.e. their beneficiary) for the purpose of paying for the beneficiary’s college expenses. There are several investment options to choose from when investing in this type of account, including mutual funds, bond mutual funds, money market funds and more.
There are many benefits to utilizing a college savings plan:
It is a tax-advantaged savings plan which means the account is not subject to income tax so long as the funds are used for the child’s college education.
- The distributions that are made for college expenses will be tax free so long as they are used for college expenses.
- Any person, not necessary the beneficiary specified can use the funds for college expenses, so if the intended beneficiary decides not to go to college, the money can be used for someone else’s educational needs, like a sibling, or even the parent.
So, what is the downfall to using a 529 Plan? Well, for starters, if the beneficiary ends up not attending college and you withdraw the funds from the account, you will end up paying income tax on all of the income earned through the years. In addition, you will have to pay an extra 10% penalty.
