Answers to several common questions
How will you ever save enough money to pay for your children’s college educations? There are no absolute guarantees, but Section 529 plans may help you set aside funds, up to generous limits. Here are the answers to several common questions on this subject.
Q. What exactly is a Section 529 plan?
A. Named after the tax code section authorizing their use, 529 plans are educational savings plans, generally operated by individual states, that encourage families to build up funds for the future education of the younger generation. If certain requirements are met, there is no tax due on the accumulation of earnings and no tax due when funds are paid out for qualified distributions.
There are two main types of Section 529 plans: the prepaid tuition plan and the college savings plan.
Q. How does a prepaid tuition plan work?
A. Essentially, the plan is guaranteed to keep pace with the rising cost of college tuition. For instance, say it currently costs $10,000 annually to send a child to a state university. You would pay $10,000 now to buy shares for a youngster. When the child is ready for college, your shares can pay for an entire year of tuition, no matter what it costs at that point.
This type of plan is often attractive to parents because it offers peace of mind. There is no risk of loss of principal, and the investment is usually guaranteed by the state.
Q. How does a college savings plan work?
A. Unlike with a prepaid tuition plan, there is no guaranteed lock on future tuition costs under a college savings plan. In fact, the savings may not be enough to cover all the costs. But you have a bigger potential upside as well, since it’s possible to generate a better return with this type of plan. (Of course, there are no guarantees.)
Usually, the plan will offer an asset allocation strategy geared to the current age of the child or the year he or she will enter school. For example, the plan may provide more aggressive investments in the early years and switch over to more conservative investments as college approaches. Most college savings plans also offer a wide variety of risk-based asset allocation portfolios that are managed by professionals.
Q. What are the restrictions on contributions?
A. Anyone can contribute to a Section 529 plan on behalf of a named beneficiary.
Each state is responsible for setting its own limits on the amount of contributions allowed to a college savings plan. Check the limits in the applicable state for your situation.
Note: In the event that a child decides not to attend college, or attends school in another state, you may be able to transfer funds to another plan or “roll over” funds for the benefit of a successor beneficiary (e.g., a younger child).
Reminder: A Section 529 plan is suitable for many parents, but it is not for everyone. Investigate the options carefully.