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Coping with the High Cost of Education

How are most families saving for college? For many families, it’s still an old-fashioned savings account. But a better solution for dealing with the high costs of education may be a 529 education savings plan.

Over the past decade, the cost of higher education has soared, yet the need to prepare young adults for a competitive job market remains more important than ever. However, despite the difficult costs of education, many Americans still don’t know about the benefits of 529 education savings plans. Named after Section 529 of the Internal Revenue Code, a 529 plan is a tax-advantaged way to save, or even pay in advance, for college expenses.

By establishing a 529 plan now you’re not only taking advantage of a potential tax benefit, you’re giving a child a helping hand toward the skyrocketing cost of higher education.

Investing In Your Greatest Asset

A 529 comes in two varieties: a pre-paid plan and a savings plan. A pre-paid 529 allows the account holder to pre-pay all or part of the tuition and fees of an in-state college education. Pre-paid plans can also be converted for use at out-of-state colleges. For private colleges, there is a similar but separate plan known as the Private College 529 Plan.

This 529 savings plan works similar to a Roth IRA and offers investment options similar to mutual funds. Its value can rise and fall based on the performance of the investment option chosen.

Earnings in a 529 plan can be tax deferred, with withdrawals being exempt from federal and state income taxes if you use the funds for qualified expenses such as tuition, fees, room and board and supplies. Many states also offer state tax deductions or tax credits on top of that.

Broad Flexibility

Another key benefit of 529 plans is their flexibility. Some investments that are used for education funding require that the assets be given to the beneficiary when they reach a certain age. With a 529 plan, the owner of the account continues to make all of the decisions. For example if the beneficiary suddenly decides not to go to college, you can choose a different beneficiary or use the plan for your own education needs.

529 savings can also be used for any accredited in-state, out-of-state or international educational institution. And while some education investment vehicles have age restrictions, a 529 plan has none, so anyone can contribute to one.

Additionally, you can usually cover full college costs because the contribution limits per beneficiary generally exceed $200,000. However, contribution limits vary by state.

Potentially Significant Tax Benefits

For tax-planning purposes, your 529 plan contribution is considered a gift to the beneficiary and qualifies for the $14,000 annual gift-tax exclusion, enabling you to make significant contributions without being charged the gift tax. Further, you can frontload your contribution to as high as $70,000 in one year ($140,000 for married couples), then distribute the gift-tax reduction over a five year period.

Assets, however, can accumulate and be withdrawn federally tax-free only if they are used to pay for qualified expenses – tuition, fees, room and board and supplies. Non-qualified distributions are subject to income tax and a 10% federal income tax penalty. 529 plans not only help reduce federal tax, they can reduce state income tax. Thirty-four states, including the District of Columbia, offer residents a full or partial tax deduction or credit for 529 savings plan contributions. A few states even offer a state tax deduction whether you invest in that state's 529 or not.

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