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Monday, 4 May 2015

When you first have kids, cute babies may occupy your mind, but thoughts of college costs can cause your head to spin.

The U.S. Department of Education estimates that a public college education will cost over $200,000 by 2030. While those numbers may seem overwhelming, those of us who aren't billionaires can still make a significant dent in our children's college costs by establishing some savings goals and setting up a smart savings vehicle.

A tax-advantaged 529 College Savings Plan is an excellent option for many people. Motivation: The Benefits of a 529 Plan A 529 plan allows you to make tax-advantaged annual contributions to a savings account specifically geared to future college tuition costs.

Most states offer at least one 529 plan (seven states currently offer other alternatives). You may invest in a plan from any state; however, you should check your home state regulations in order to maximize tax benefits.

While rules vary from state to state, the basics are the same:

  • Monthly deposits: You make monthly deposits into an account (a minimum monthly deposit of $25 is typical) set up in a child's name. 
  • High contribution limits: Unlike many other savings vehicles, 529 plans have extremely high contribution limits (over $350,000/year in some states). Check to see what the limits are in the plan you choose. 
  • No federal income taxes on earnings: A great tax advantage is that you pay zero federal income taxes on the 529 plan's earnings, as long as the funds are used to pay eligible education expenses, such as tuition, and room and board. Depending on your personal tax situation, this can result in a substantial benefit
  • State Income tax deductions may apply: Nearly every state with a state income tax offers a tax deduction for contributions to 529 plans. Many states require you to have an in-state 529 plan in order to qualify for state income tax deductions, but others allow tax-deductible contributions to any state's plans. Check your state's 529 plan regulations before selecting a plan. 
  • Anyone can contribute: Contributions to a 529 plan are not limited to family members. You can ask friends and relatives to contribute a cash gift toward a college education in lieu of another plastic toy. (It will make a much longer-lasting impression than another doll or toy truck.) 
  • Bonus points: Students with their name on a college savings account are six times more likely to attend a four-year university. 

The nuts and bolts: How 529 plans work

The beauty behind 529 plans is their simplicity and wide applicability. They can be used at qualified schools nationwide (including vocational schools). In most plans, you can be a Florida resident, invest in a New York plan and send your student to college in South Carolina. Rules vary from state to state, but information is readily available online.

The parent usually controls a 529 account, with the child named as the beneficiary. This means you call the shots and decide when withdrawals may be made. If the child named in the 529 account decides not to go to college, the money can be used for another family member's higher education with no penalties. Most plans allow you to reclaim the funds at any time, no questions asked.

However, if the money is used for anything but college expenses, the funds are subject to applicable federal and state tax rules, plus a 10 percent  penalty on any earnings the fund made.

A 529 plan won't disqualify your child for financial aid. Only a small portion of the account (5.6 percent of the total balance) is counted as “income" in the federal student aid formula.

The set up: Some homework required

Setting up a 529 plan is pretty simple: you'll need to sign paperwork to open the account, and then set up a monthly contribution plan. In order to get the most out of your 529 plans, however, you should do a little research. We suggest using the following guidelines to get the most out of any 529 plan:

  • As a first step, research your own state's 529 plans. 
  • Compare features across different states' 529 plans. Features vary by state; you want the one that is best for your family. 
  • Set up a 529 plan for each child. 
  • Make direct deposits into the account. Even if you only deposit $10/week, it will add up and can make a significant contribution to your children's educational costs. 

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