College is expensive, and it's expected that future costs will only continue rising. You know that you should start saving money, but there are multiple savings vehicles, and you may not know which is best.
One of the best are 529 plans. They can help you save money and reach your education goals more quickly. Here's are six reasons you should open one and get all the benefits they offer before the end of the year.
1. Tax-deferred growth
When you add money to your 529 plan, your contributions, as well as any earnings, grow tax-deferred. As long as you use your 529 plan for qualified education expenses, your withdrawals will also be tax-free. If instead, you use a brokerage account and invest in stocks or funds, you could owe taxes on any dividends paid or capital gains distributions that your mutual funds/ETFs make. You may also owe Uncle Sam capital gains taxes on the profits of any investments that you sell. These taxes can eat away at your investment profits.
2. High contribution limits
529 plan contribution limits are set by individual states and the states with the lowest limits (Georgia and Mississippi) allow contributions up to $235,000 for each 529 plan. California has the highest limit currently and will let you contribute $529,000 to each 529 plan beneficiary. This comes in handy with hefty education costs.
However, there are a few gift-tax considerations to keep in mind when you're contributing money. Each year, you can add $15,000 per year per beneficiary and it will count toward your yearly gifting. You're allowed to bundle five years' worth of these $15,000 annual exclusion amounts into a single deposit, but you forego the ability to make subsequent annual gifts for five years. If you contribute more than the limit, you probably won't owe taxes on the excess right away. However, you need to file a gift tax return on IRS Form 709, and it will also count toward your lifetime exemption from gift and estate tax.
3. Potential state tax deduction
You don't get a federal tax deduction for your contributions, but depending on the state you live in, you might get a state tax deduction or tax credit.
For most states, in order to qualify for a tax benefit, you must contribute to your state's plan and your state will most likely place a cap on the amount that you receive a tax benefit for. There are some states that offer you a tax benefit for your contributions, even if you don't open up a plan in that particular state. They are Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania.
What you can count as a qualified expense is pretty vast, too, and isn't just limited to tuition. Your 529 plan can also pay for things like books, computers, and even student loans. They don't just cover college costs, either -- you can use your 529 plan for paying tuition at elementary, middle, and high schools, as well as qualified training programs after high school (post-secondary).
What if your child decides post-secondary school isn't for them? You can transfer the balance of your 529 plan to another child if this happens. If you don't have anyone that you can transfer the money to, you can use the money yourself, but you'll pay taxes on your withdrawals, as well as a 10% penalty. You're exempt from this penalty if your child receives a scholarship, but only up to the dollar amount of the scholarship.
5. Easy investment options
Choosing the actual investments in your account is hard and inaction can come if there are too many options. Most 529 plans make investing simple for you with choices like pre-set asset allocation models and age-based options.
These options are professionally managed, so you don't have to perform actions like rebalancing your account every year. The age-based models add an extra layer of ease because they become more conservative as you get closer to the date when you plan on using your money. This will lower your risk and your chances of losing a substantial amount of money when you need it most.
6. No tax reporting for qualified education expenses
If you use your 529 plan funds for qualified expenses, you can skip reporting them for tax purposes. This makes your life easier around tax time when you're compiling all of your important documents.
If the amount of your withdrawals exceeds your qualified education costs, the excess does get reported. It's up to you to report it on Form 5329 when you complete your taxes. You may owe taxes on that excess, as well as the 10% penalty, depending on what it was used for.
If you're looking to save for education expenses, 529 plans are great tools. You can make the most out of these investment vehicles if you plan in advance for how much money you'll need and how you will use it. As always, you should take your individual circumstances into account, but if college or any expensive schooling is a part of your child's future, you should strongly consider this vehicle as a part of your plan.