529 Account

529 Account Provides the Best Education Account

Years ago, we started saving for two children to go to college.  After listening to several people complain about the cost of tuition, we decided to save for it.  We looked through all sorts of accounts.  We found a 529 account which is the best type of account for education savings.

Other Types of College Savings Accounts

The Coverdell Education Savings Account is a custodial account to pay the qualified education expenses for a designated beneficiary.  The benefit covers both higher education and including elementary and secondary education.  The beneficiary must be under the age of 18 or with special needs when the account is established.  The account must be designated as a Coverdell account when it is established.  The contributions are not tax deductible.  The total contributions cannot exceed $2,000 in any given year.  The distributions are tax-free to pay for qualifying expenses.  In most cases the account must be distributed by the time a beneficiary reaches 30 years of age.

Withdraw from an Individual Retirement Account prior to 59 ½ years is allowed for qualified education expenses without a 10% penalty.  While this may provide some temporary relief to pay for college, it stops any growth for retirement.  Retirement accounts are usually a significant part of the family net assets.  This makes them appealing for college expenses, but this account is designated for retirement.  Retirement savings is vital for the family’s future security.

A traditional savings account does provide a way to save for college.  Unfortunately, a savings account provides a low interest rate that is insignificant.  Currently, saving accounts provide 2.15% APY at the best.  Paying for college as the student goes may account for such a high percentage.  “Pay as you go” or cash flowing the expense makes sense for late savers.

Many colleges provide prepaid college plans to lock in tuition expenses at a certain rate.  This makes sense if the parent and student are agreed about the school that they will be going to.  Since life is uncertain, prepaid college plans present a challenge if the student cannot attend. 

Information about the 529 Account

We have used the 529 Education Savings Account for several years.  Like a retirement account, the 529 account is designated for the specific purpose of education.  As a designated account by the IRS, there are many tax advantages.  Some of the recent changes to 529 accounts include expanding the qualified educational opportunities.

There are relatively few restrictions on the named beneficiaries.  The account is opened in the beneficiary’s name.  While the beneficiary’s name is on the account, control of the account remains with the custodian.  This provide the advantage of maintaining control. 

The 529 account has been expanded recently to include many educational opportunities.  Most colleges are covered, and many trade schools, primary schools and certification programs are also eligible.  The change to allow private school tuition was a great benefit for parents and grandparents with younger children.  For non-college bound participants many trade schools and certification programs are also eligible.

Education can be expensive and there are many expenses that come with any program.  The 529 account can be used for any qualifying expense.  The qualifying expenses include:

  • Tuition in a qualified program
  • Books required by the course or program
  • Fees required by the course or program
  • Computer equipment that is required
  • Other miscellaneous supplies that are required

While this does not cover room and board or general living expenses, the qualifying expenses do help defray the cost of room and board.

Available Tax Benefits

Several providers for the 529 account and choosing different providers could impact the tax benefits.  Many states qualifying account are administered by the state or a designated group.  This provides state tax benefits if you pay taxes within the state.  Many states also allow participants from other states and this would likely prevent the state tax benefit.  There may also be the ability to reduce your effective net income by investing in a 529 account.

Annual Limits

The main advantage to a 529 account over the other accounts is the annual limit.  At $15,000 per beneficiary the annual limit far exceeds any of the other account types.  By using a 529 account, the amount deposited also does not reduce your ability to deposit into other accounts such as retirement accounts.  By maintaining tax advantaged accounts for specific purposes, you can increase the total savings throughout your portfolio.

Tax Implications

Consideration to the taxes should be paid to both the contributor and the beneficiary.  The contributor can effectively reduce their tax burden for the year of the contribution.  The money will grow in the account tax free provided it is used for qualified expenses.  The beneficiary claims the distribution as ordinary income during the year the distribution is made.  Since the distribution will be made to a student, the tax burden is far lower than the contributor.

Mechanics of the 529 Account

Choosing the right account can be challenging. 

  1. Consider the state plan where you live.  Normally there will be a tax advantage for your state. 
  2. Consider the fee structure of the account.  The fees vary a great deal between accounts.
  3. Consider your risk tolerance.  The 529 account can be structured in many ways such as balanced funds, bond funds and equity funds.
  4. Consider the institution that maintains your account.  Most investment institutions have a department that handles 529 accounts.
  5. Call the institution to open an account.

Now, I have provided you with several types of accounts.  If you would like to know how to save more money for college check out these money savings tips.  If you would like to reduce the overall cost of college tuition check out the case for community college.  Don’t let education expenses catch you by surprise!  Start a 529 account today to protect your financial future.  Education is an important part of that future so prepare for it!