College Fund Jar

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A 529 savings plan can be a great way to save for your child or other loved one's college education, but it's not like other investment accounts. There are some key facts about 529 plans you need to be aware of before signing up, such as the rules governing how the money can be used, where to look for the best plan, and what you can invest in. Here are the details about each of these, courtesy of our contributors.

Matt Frankel: One thing you need to remember about your 529 savings plan is that the money absolutely needs to be used for higher education expenses, even if the beneficiary doesn't go to college, or doesn't need the entire amount in the account. Withdrawing money from a 529 for an unqualified purpose can result in a 10% penalty from the IRS.

Fortunately, 529 savings plans are easily transferable. If the designated beneficiary doesn't need the money, it can be transferred to a sibling, cousin, grandchild, or other relative -- even to yourself.

This can actually be a good strategy to take full advantage of the tax-free compounding of a 529 plan. Let's say that you have three children, and your oldest child has a 529 savings plan with $100,000 in it -- the result of 18 years of contributions and tax-free compounding. If that child receives scholarships and only needs to use, say, $30,000 to pay for their college, the remaining $70,000 can be transferred to one of the younger children and enjoy several more years of tax-free compounding.

If there is still money left over after your youngest child goes to college, you could change the beneficiary to a grandchild, and let the compounding continue.

The point is that although the need to use the money exclusively for higher education expenses may seem like a big restriction, it actually encourages you to take advantage of the 529's most powerful feature -- compound growth -- for your other loved ones as well.

Selena Maranjian: One thing about 529 plans that surprises many people is that, although each state has its own plan -- or several -- you're usually not limited to using a plan based in your state. Indeed, depending on where you live, it's possible you should not use one of your state's plans, if you can do better elsewhere.

The Internet makes things easier by helping you compare features of the scores of plans out there. The SavingforCollege.org website is a great place to research plans, and at the College Savings Plans Network's website, for example, you can select specific plans from different states and then compare their features, such as whether there are state matching grants available, whether there is a state tax credit or deduction available, the fees charged, minimum initial contributions, investment options for each plan, and much more.

It's important to review these factors and to consider them together. One plan in a different state might have lower fees than your state's plans, or it might offer better investment options, but keep in mind that your state might offer in-state folks an extra benefit or two, such as matching contributions (free money!) for those at certain income levels, reduced fees, or state income tax deductions or credits. You'll need to determine whether the in-state perks make your state's 529 plan the best choice. Some highly regarded plans are based in states such as Maryland, Alaska, Nevada, and Utah.

Jason Hall: 529 plans are different from other kinds of personal investing accounts, such as taxable brokerage accounts and traditional and Roth IRAs, where you can pretty much invest in anything that your broker offers. 

With a 529 plan, you'll be limited to the investments available in that particular plan, much as the 401(k) plan your employer offers probably has a specific selection of investment choices, typically a group of mutual funds that invest in stocks, bonds, or a mix of both. 

You may also have to pay maintenance and management fees, and may have to pay an out-of-state fee if you choose a 529 that's not based in your state of residence. So before you just pick the 529 that's available in your state, or the one your online broker recommends, shop around and do some research to find the one that gives you the very best blend of low fees and superior investment choices. 

Two personal favorites are the College Savings Iowa 529, and the Vanguard 529 sponsored by  Nevada. Both have some of the lowest costs, and offer a range of inexpensive Vanguard index funds to choose from. If you're looking for a simple, low-cost 529 plan, these two are at the top of my list. If you want more investment choices, you may want to look around to find a 529 plan that lets you invest in the funds you want. 

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