Americans have invested a record $179 billion in 529 College Savings Plans, and yet what may be the most accessible and simplest way to save for college is still incredibly misunderstood.
Fewer than one-third of Americans say they know what 529 Plans are, according to a recent survey by financial services firm Edward Jones. That's a six-point dip from last year.
True, a 529 plan isn't the only answer to soaring tuition costs, but from the looks of this survey, consumers are sorely in need of a refresher.
Here's what you need to know:
What is it? In short, a 529 plan is a tax-advantaged savings fund that can be set up for anyone heading to college (in-state or not). There are two main plan types: a prepaid tuition plan, which lets you pay for tuition ahead of time based on today's costs, and a "savings plan" that functions like an investment account, growing (and falling) with the market. Every state's offerings are different. There are pros and cons to each. Head over to the College Savings Plans Network to compare the benefits of various plan features.
What can you use it for? The best perk of 529 plans is the ability to pay for a host of college-related expenses, including tuition, room and board, books, computer equipment, and even Internet access, all tax-free. The plan beneficiary has to be enrolled in school to qualify for the computer and Internet perks, though.
Who can open one? Anyone in the country can open a 529 Plan in anyone else's name –– from your niece or nephew to your best friend's kid or that friendly neighbor next door. There's no limit to how many plans you can open either, and you can even change the beneficiary whenever you want.
How are they funded? Each state offers at least one form of a 529 savings plan (see a full list here), but there was some doubt as to whether cash-strapped state governments would be able to meet demand in the wake of the recession. However, a recent report by the College Savings Association showed plans were successfully funded at a rate of 93% in 2011 –– up 2 points from the prior fiscal year. Not everyone investing in plans necessarily taps into them at the same time.
Is there a catch? The only downside is that there are limits to tax-free contributions. Generally, you can put as much cash into the fund as the beneficiary needs to meet college expenses, which will take careful calculations to figure out (use your school's tuition calculator as a gauge). Any contributions that exceed $13,000 in a given year might incur a federal gift tax.
Don't be afraid to shop around. Just because your state offers its own 529 plan doesn't mean you can't sniff around for better offers in other states. Students aren't required to attend college in the state where their plan is funded. MorningStar's interactive state-by-state map is a great way to compare plans.
They're not for everyone: Before deciding to invest in a 529 plan, seeking advice from a financial planner or tax consultant would be a wise choice. Basically, treat them like you would enrolling in a company retirement plan. Keep tabs on them over time and adjust your investments to reflect your risk tolerance as time goes on. The IRS and the College Savings Plans Network both offer helpful starter guides as well, which will give you talking points to cover.
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