How does 529 savings plan work

The table below illustrates current college costs and the recommended amounts to save each month for a future student. Assumes current inflation rates of 3. All other expenses are non-qualified. If the designated beneficiary decides not to go to college , you can always change the beneficiary to another qualifying family member , save the funds for a future grandchild or use the money to further your own education.

Or, you can take a non-qualified withdrawal at any time for any reason. Only the earnings portion of the distribution will incur taxes and penalty. Your contributions the principal will never be taxed or penalized since they were made with after-tax dollars. Technically, prepaid tuition plans are also plans, but everybody calls them prepaid tuition plans. Hardly anybody calls them prepaid plans any more.

A prepaid tuition plan locks in tuition at current rates by letting you buy tuition units or years of tuition. But, you will usually have to pay a premium on current tuition rates, to make up the shortfall between investment returns and increases in college costs. Many prepaid tuition plans are suffering from actuarial shortfalls and do not have enough money to cover all future tuition obligations.

Some prepaid tuition plans offer guarantees, but their guarantees may not be backed by the full faith and credit of the state.

Many prepaid tuition plans have closed to new investment and will not cover full tuition costs. The money might not be there when your child is ready to use it. By Mark Kantrowitz August 2, Tax and financial aid benefits Named after section of the IRS tax code, which was added in , college savings plans provide families with several tax and financial aid advantages.

Other benefits of plans In addition to the tax and financial aid advantages, plans offer several other key benefits. Type of school annual cost Projected total cost. Recommended Articles. Related Articles Celebrate National Day. For many families, plans will be the obvious choice for college savings. Most plans offer age-based investment options that will automatically rebalance, taking more risk as your child is young and less as they approach college age.

What is a plan? The account holder maintains ownership of the funds. Qualified distribution rules are strict. The bottom line. On a similar note Dive even deeper in Investing. Explore Investing. Get more smart money moves — straight to your inbox. Remember, you will need to check with your own plan to learn more about how to take distributions.

Depending on your circumstances, you may need to report contributions to or withdrawals from your plan on your annual tax returns. Generally, you will pay income tax and a penalty on the earnings portion of a non-qualified withdrawal, but there are some exceptions. The penalty is waived if:. However, the earnings portion of the withdrawal will be subject to federal income tax, and sometimes state income tax.

If you have leftover money in your plan and you want to avoid paying taxes and a penalty on your earnings, you have a few options, including:. Remember, you can withdraw leftover money in a plan for any reason. However, the earnings portion of a non-qualified withdrawal will be subject to taxes and a penalty, unless you qualify for one of the exceptions listed above.

If you are contemplating a non-qualified distribution, be aware of the rules and possible tactics for reducing taxes owed. Prepaid tuition plans are another type of qualified tuition program.

Prepaid tuition plans let you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges. Most prepaid tuition plans are designed to save for an in-state public college, with the exception of Private College , which is a prepaid plan sponsored by more than private colleges.

Educational institutions can offer a prepaid tuition plan but not a college savings plan. Opening a college savings plan is easy. Direct-sold plans offer lower fees than advisor-sold plans, but the account owner is responsible for selecting the investments. Advisor-sold plans are only available through licensed financial advisors.

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