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529 Plans: 4 Reasons They're Great; 1 Day to Consider Them

In honor of 529 College Savings Day on May 29, here are four reasons why 529 plans are worth considering for your college savings needs.

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Across the nation, more than 4 million teens will graduate high school this spring, according to the most recent figures from the Census Bureau, and many of them will go straight to college this fall. And among their parents, those who've prepared in advance for the financial burden ahead will likely be able to attest to the value of college savings plans, particularly 529 plans.

The number 529 refers to the section of the Internal Revenue Code that allows these tax-advantaged plans. It also has inspired states and others to promote 529 College Savings Day on May 29. In recognition of that, here are four reasons why 529 plans are worth considering for your education savings needs.

1. There Are Great Tax Advantages

Ordinarily, when you save money for a long-term financial goal, you have to pay taxes on the investment income it generates. Further, when you sell your investments in order to raise cash to make payments, you'll typically owe even more tax on the capital gains on those investments.

Investments in 529 plans, however, build up on a tax-deferred basis, meaning that even if the investments you select pay interest, dividends or other forms of income, you won't have an immediate tax bill. More importantly, if you use 529 plan money for qualifying educational expenses -- including tuition, required fees, and even room and board for those students who are enrolled at least half-time in college -- then those withdrawals become tax-free. The earlier you start saving for college, the more those tax advantages add up.

2. You Can Make Huge Contributions

Some options for college savings have very limited contribution limits. For instance, Coverdell Education Savings Accounts have many of the same tax advantages as 529 plans, but they only allow you to contribute $2,000 annually toward a child's college education.

Limits for most 529 plans, however, are much higher. Each state's plan has a different maximum account value, from around $235,000 to as high as $400,000. That gives most families all the flexibility they need to save for their children's college education.

3. They Have Financial Aid Advantages

Many parents neglect to consider the impact of their savings decisions on financial aid awards. For instance, if you open a custodial account in your child's name, those assets are considered the property of the child, and financial aid awards will take a greater percentage of those assets into account, potentially lowering how much aid you get .

By contrast, even though 529 plans are held for a specific student beneficiary, they're treated for financial aid purposes as property of the parent as long as the parent is the named owner of the 529 plan account. A much smaller percentage of parents' property is included in the expected family contribution toward college costs, and so using 529 plans wisely can boost your financial aid.

4. They've Gotten Better -- And Cheaper

Over the years, 529 plans have evolved. In the past, limited investment options with high fees made 529 plans a somewhat less attractive option.

But now, many of the most popular plans extensively use index mutual funds and other low-cost investments as their primary savings vehicles, and that leaves more money for you and your child to use for college costs. In addition, with target-date funds that automatically invest less aggressively as your child's college start-date approaches, you can save for college without constantly worrying about whether to make your own adjustments to your investing approach.

It's important to remember that there's no requirement that you use the 529 plan that your own state offers. In some cases, your state will offer state-tax incentives to participate. But it's often worth looking outside your home state for the best deal.

You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google Plus.


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Paul Hemphill

Why would anyone risk one dime on their child's education, money that is subject to market conditions? That's what a 529 plan does. This article doesn't take into account each college's policy on 529s. One college may treat it as a parent asset and penalize the student at a rate of 5.6%, that is, 5.6% of the 529 plan will be subtracted from any financial aid package. Or, a college could penalize the student at a full 100%. Scary, huh? It would be advisable to check on how colleges work instead of telling the reader how 529s work. Context, please. http://www.planning-for-college.com

May 30 2014 at 8:48 AM Report abuse rate up rate down Reply