The average cost for college tuition, fees, room and board for the 2018-2019 school year is $21,370, according to College Board. That’s for an in-state public school. It goes up for out-of-state or private education.
If you’re going to be paying for a portion of, or all of your child’s higher education, you need to have a college savings plan.
One of the best options is a 529 plan.
What is a 529 plan
A 529 plan is a tax-advantaged college savings plan, administered at the state level. At the most basic level, you contribute your 529 plan with after-tax dollars. The value grows over time and any gains can be withdrawn tax-free for educational costs. Your specific plan will outline the requirements for what meets the definition of an educational cost. Ineligible withdrawals will be taxed (gains only) and a 10% penalty applied.
You are not limited to your own state’s plan. For example, you can be a resident of North Carolina but invest in Arizona’s 529 plan. However, your state’s plan will likely offer a tax benefit on the state income taxes you pay. The features and benefits of each state differ, so it’s worth taking some time to do your research.
What if my child doesn’t go to college?
Because our futures are uncertain, you will (rightfully) question whether your child really needs a 529 plan. After all, they may not attend a traditional 4-year college. Here are a few points to consider.
529 plans will cover any higher education costs. Your child may be interested in a vocational school such as carpentry school, or cosmetology school. If you have a budding entrepreneur on your hands, encourage them to take a marketing, or web design course at your local community college.
You can change the beneficiary to another child. If you have more than one child, you can change the beneficiary over to them. Additionally, you can allow the plan to grow and transfer the beneficiary to your children’s children when they’re ready to go to college. It’s a great way to establish a legacy.
A 2018 tax law change allows a 529 plan to be used for K-12 education costs. If you’re considering private school for another child in your family, you can change the beneficiary and use the plan to pay for their primary education. At the time this post was published, not all states have conformed to the new law, so you’ll want to pay close attention to the fine print before withdrawing any funds to avoid a big state income tax bill come April.
Finally, as a last resort, you can pay the penalty and withdraw any monies from the plan.
Alternatives to a 529 plan
A 529 plan is not your only option for college savings.
You can go the traditional route and deposit every month into a traditional savings account. Depending on your level of financial discipline, this may work. However you will lose the benefit of withdrawing any gains tax-free, and the gains will likely be minimal due to the low-interest rate paid on a bank savings account.
Furthermore, you may want to consider a Coverdell Education Savings Account (ESA) which operates similar to a 529 with fewer restrictions. Additionally, you can use a Roth IRA or a custodial account such as a Uniform Gift To Minors Act or Uniform Transfer To Minors Act which are both options that provide for tax breaks but allow more freedom to choose how the cash is utilized upon distribution.
Are you currently investing for your child’s future education? Let us know in the comments below.