Saving for College Pt.2
Since saving for college should take more than five years we need to consider it a long term investment. Just like saving for retirement there are types of accounts that have tax advantages. The most widely used plan is called a 529 plan.
All 529 plans are sponsored by a state. Meaning there are 50 different 529’s (I have a quick guide here). You can put your money in whichever state plan you want and can spend that money at whatever college you would like to. The money going in is post-tax (meaning you have already paid taxes on it) and grows tax free (meaning you do not have to pay any taxes on the interest) if you you use it for college expenses, such as tuition, fees, books, supplies, and room and board. Basically the 529 is the college savings equivalent of a Roth IRA. Many states offer tax deductions on state income taxes for residents if you contribute to their plan. If you live in one of these states you will want to contribute to your state’s plan. If your state is not listed here you will want to choose a different state. Any state not listed on this list either has high annual fees or requires you to purchase the plan through an intermediary that will charge you a commission.
There are a few other rules you have to follow with these plans. The first is that they are associated with a single beneficiary. So if you have kids that will be in college at the same time they will each need an individual 529 plan. You can, however, transfer the plan from one beneficiary to another. Therefore if you have two children that are more than 5 years apart (the average student graduates in five years now) you can transfer the account to the younger child before they go to college. Now everyone thinks their child is a genius and, some of them, are smart enough to get scholarships. If this were to happen you can transfer that money to a sibling or relative or it can be withdrawn. If the money is withdrawn for non-higher education expenses then you will have to pay the taxes on the interest earned and a 10% penalty. I was just in a financial class where a young lady, whose parents used a 529, had done just that. She used the money to put a down payment on her house. What a great set of parents!
The only other thing you need to remember is to use the mutual fund investments available in these plans. You don’t want to be investing in bonds or money market accounts. These are long term investments and should be treated as such. Do your home work but invest in mutual funds.
In part three of this series I will be discussing the other tax advantaged type of college savings account. See you there!
