If you are putting away funds dedicated for your child’s higher education expenses, a 529 College Savings Plan is tough to beat. These plans allow parents and grandparents to put away funds for a child’s education, and the growth on the account is tax – free when used to pay qualified education expenses.
In some respects, a 529 College Savings Plan looks and feels like a retirement account. Most include a basic set of investment options. You make deposits to the account on your own schedule. Each state has their own 529 College Savings Plan, so the details may vary, but contribution limits are usually quite generous, and there is no limit to contributions based on household income.
Here are the highlights of how a 529 College Savings Plan works:
- The parent is usually the owner of the 529 plan and the student is the beneficiary of the account. The parent retains control of the funds and can change beneficiaries to a different family member, even to themselves, if the original beneficiary doesn’t need the funds.
- The definition of qualified education expense is very broad, and can include most legitimate student – related expenses, from tuition, room, board and books to computers and printers. The funds can be used at most post – secondary schools. While every state has its own 529 plan, you aren’t restricted to using the account for in – state schools.
- The funds grow tax – deferred, like an IRA, and distributions are tax free if the funds are used for qualified education expenses. The contributions are not deductible for federal tax purposes, but some states allow a deduction against income tax if you use your state’s plan (Michigan allows up to a $10,000 / year deduction against Michigan income tax).
- The funds can be used by any family member. If the original beneficiary does not use all the funds in his or her account, the beneficiary can be changed to siblings, parents, aunts and uncles, or even cousins.
- Anyone can contribute to a 529 plan once it’s established. Often parents will open an account for their children, but grandparents, aunts and uncles can add funds as well. Some plans allow you to print gift certificates showing that you made a contribution to a student’s fund for birthdays or Christmas.
- Parent – owned 529 plans have a lower impact on financial aid eligibility than accounts owned by the student. They are treated as parental assets, which are assessed at 5.6%. Savings in the student’s name are assessed at a higher rate (20%) for federal aid purposes. A 529 plan is still a great way to save for a family that may be eligible for help paying tuition.
- If the funds are not used for education, it’s not the end of the world. If you take a non-qualified distribution from a 529 plan, you will need to pay income tax plus a 10% penalty on the earnings. Note, however, that the amounts you put in the account as contributions are tax – free and penalty – free, regardless of how they are used. Only the growth is taxed or penalized.
- Opening a 529 Plan is usually quick, easy, and cost – effective. The Michigan 529, called the Michigan Education Savings Plan (MESP) can be opened online at misaves.com. The owner will need to provide their Social Security number, address, and date of birth, as well as the beneficiaries’ information. You can start an account with as little as $25. The MESP uses inexpensive no-load mutual funds that are very cost effective. Be aware that many states, including Michigan, also offer a “broker – sold” plan that uses more – expensive funds.
- In the case of the MESP, the investment options are very simple and include a guaranteed option and age – based options. For most clients, I recommend the age – based options, which will start out taking more risk for a young beneficiary, but automatically become more conservative as the beneficiary approaches college age.