Understanding the 529 Savings Plan

Saving up for college may be one of the most important things you do for your children. It is an expensive period in their lives, so the sooner you start saving, the easier it will be to pay for everything. You can save for your child's education by stocking some money away each month or purchasing grants, but you should also look into savings plans, including a 529 plan.

This type of plan is fairly simple to enroll in and can provide you with some tax benefits. Although the enrollment process is pretty straightforward, there are additional rules and parameters that go along with it. Misreading or misinterpreting the language of a 529 plan could cause you to lose money or even have a negative impact on your credit score. Here is a primer about a 529 plan and everything that goes along with it:

Two types of plans
A 529 plan will allow you to store money into a savings account that will then grow over the years. As a parent, if you put money into this account early, you could see it grow exponentially over time, which can help pay for tuition and other school expenses. There are two types of 529 plans for you to choose from:

  • Prepaid tuition plan: This type of plan allows you to prepay for college expense with current rates. Prepaid plans can be beneficial in the case tuition rates rise or other purchases become more costly.
  • Investment plan: This 529 plan allows you to invest money in stocks, bonds and mutual funds in order to grow your initial investment. Your contribution will increase over the years, but there is generally a cap of $200,000.

Both these plans can help your future college student, but you are only allowed to use the investments for college-related expenses, including tuition, textbooks and housing. If you take out the money early and use it for non-school related items, you could incur fees from the government.

Tax deductions
Along with helping pay for your child's schooling, a 529 plan offers several tax advantages. The earnings you make from a 529 plan will not be charged federal or state taxes as long as you use the earning for school-related expenses.

If you choose to use these earnings for items that are not going to pay for schooling, you will have to pay income tax and a 10 percent penalty. Each state offers their own benefits as well, so make sure to check to see if your local government can give you a break.

Several risks to be aware of
While this type of savings plan can be a great financial tool, be forewarned that there are some of the risks involved. If you enroll in an investment plan, your earnings will be affected by how the market fares. If you have invested a considerable amount of money into some stocks and the market is not doing well, you may not get back as much as you want.

You will also be charged some fees if you decide to sign up for this plan. Enrollment, annual maintenance and asset management are just a few of the fees you may have to deal with.

A 529 plan is a very common route for parents who are looking to finance their children's educational future. If you feel this is an avenue you are willing to take, make sure you read all of the fine print before deciding if it is for you.