College Savings

By Catherine McNulty

November 19, 2010 4 min read

A college education is the best way to ensure your child has a bright future. The benefits of a college education are numerous: better employment opportunities, better pay, less entry-level grunt work, etc. In a lot of fields, having a degree is no longer optional; it's required.

But college doesn't come cheap. Tuition at state schools currently costs about $12,000 a year. Private institutions cost about $27,000 a year; an Ivy League education can set you back more than $36,000 a year. And the cost of college is expected to keep rising. Today's preschoolers can expect to pay in excess of $240,000 for a four-year education.

When is the right time to start saving for college? Right now, if you haven't already! But how do you even start a college savings plan?

Forget traditional savings accounts; you won't get any special tax breaks or earn enough interest for it to be worth it. Every state has a 529 plan (so named for the section that details it in the Internal Revenue Code) for college savings. What is a 529 college savings plan, and how do they work?

The plans vary from state to state, but very basically, they allow you to save money federally tax-free for future education costs; state tax breaks vary from state to state. The money can be applied to tuition, books, room and board, and even some electronics, such as personal computers. You even can start a plan in a state you don't live in and have the money applied to an out-of-state education.

You can open a 529 college savings plan for anyone, not just your children. This includes your spouse, your grandkids, a friend and even yourself. It should be noted that the account owner (the person who starts the account) controls the funds, not the beneficiary. In certain circumstances, the account owner can change the beneficiary without penalty. So if you have money left over in one account, it can be used by another person.

Once you set up a plan, it's very hands-off. You can select to have money deposited directly into the account weekly, every pay period, monthly or yearly, and then you leave it until you are ready to withdraw the funds. Anyone of any income bracket can start a 529 plan.

Another special benefit of the 529 plans? Anyone can contribute to an already started one. Additionally, there's a special rule that allows for people to gift up to five years' worth of money in a single drop without incurring any gift tax. Typically, a person can gift only up to $13,000 a year ($26,000 for joint tax filers) before incurring the gift tax, but with a 529 plan, $65,000 ($130,000 for joint tax filers) can be gifted at once without incurring the tax penalty.

Having a 529 plan can affect how much federal aid the beneficiary receives. But considering that most federal aid takes the form of loans that need to be repaid -- whereas the 529 funds are just fully available -- the benefits outweigh the disadvantages.

What if your child is a genius who gets a full ride to Harvard? Or what if he decides not to go to school? Fear not, because your money will not be wasted. In addition to transferring the funds to a different beneficiary (including yourself if you've always wanted to go back to school!), you can keep the money in the 529 plan indefinitely, so if your child decides to go to school in the future, the money will be available. It can be transferred to someone in the next generation, just as soon as he/she is born and assigned a Social Security number. Or you can take the money out of the account, with a 10 percent penalty on all non-qualified expenses.

Don't be intimidated by the complicated tax codes and IRS jargon! There are plenty of experts and organizations dedicated to helping families find the right plan and start saving for college. Don't be afraid to ask questions until you fully understand the benefits and consequences of each plan. Your child's future may depend on it.

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