What Are 529 College Savings Plans?

Joel Anderson  |

The value of a college education is more clear today than ever. As the manufacturing base in America continues to erode, the idea that a solid job can be had without only a high school diploma seems less likely today than it ever has. However, at the same time, the news is also abound with stories about student debt and its potentially serious consequences.

The moral of the story? There may be few things a parent can do for their child more important than saving for a college education. However, precisely how to do this can be a daunting question.

One popular method, though, are 529 plans. With a wide array of investment opportunities available to the investor looking to secure tuition at a top-tier college or university for their children, 529 plans offer a way to avoid taxation under the IRS code and ensure that money invested today will result in an education tomorrow.

The origin of the term 529 Plans is section 529 of the Internal Revenue Service Code that outlines them. There are two basic forms of 529 plans. The first is tuition credits, whereby one can purchase tuition credits for a beneficiary at current prices for use in the future. As such, any inflation in tuition costs over time would be money saved by the purchaser.

The other form are savings plans, whereby one can invest in approved mutual funds that offer age-based allocations that grow more conservative the closer the beneficiary gets to college-age.

The benefit to 529 Plans comes primarily from avoiding taxes. Earnings are not taxed by the federal government for qualified withdrawals (i.e. money spent on approved expenses like tuition, fees, books, etc.), and most state government offer similar protection from taxes.

In short, it's a way to save money tax free provided that it ends up going toward paying college tuition or fees. What's more, while contributions to 529 plans aren't deductible from federal income taxes, most states offer income tax deductions on contributions.

However, while the plan has a named beneficiary, it remains in the control of the person making the contributions. Should the designated beneficiary decide to study primitive basket weaving at an expensive private university and the level of parental support subsequently dries up, the account holder can choose not to release the funds saved for a college education.

Granted, they will have to pay taxes on any "unqualified withdrawals" (i.e. the boat you can buy with the money you planned on spending for your child's education) along with a 10 percent tax penalty, but the option is there.

Finally, 529 plans can be appealing because of their hands-off nature. Investing in a 529 plan involves signing up and making a contribution, but no 1099 forms need be filled out until the year of the withdrawal. What's more, the investment is handled by the plan and doesn't necessitate the donor's attention. With low start-up costs, contributions, and fees, these plans can be an easy way for parents who aren't active investors to begin saving for college.

With so much chaos in the markets, economy, and for that matter the world, the relative safety and reliability of a 529 plan can be very appealing to many parents and investors looking to save for their children's future. What's more, they offer a variety of tax incentives that should give ample reasons to save.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer.

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