A qualified tuition program, also known as a 529 plan, provides tax benefits for savings intended specifically for college expenses.
This tax-advantaged college savings account allows you to grow your savings tax-free, and allows your beneficiary to take distributions tax-free for qualified education expenses.
There are a number of similarities between 529 college savings plans and Coverdell ESAs.
In a 529 plan, you also can change the account’s beneficiary to a beneficiary’s family member. While you have the benefit of tax-free earnings for qualified expenses, earnings withdrawals for nonqualified expenses are subject to tax, along with a 10-percent tax penalty. (Your 529 contributions, as with the Coverdell, are made with after-tax dollars, so they are not taxed on withdrawal.)
There also are important differences in comparing the two accounts.
A 529 college savings plan has no age restrictions, so you can continue to make contributions after your son or daughter turns 18, unlike with the Coverdell. You also can leave those contributions in that account after the beneficiary turns 30, for graduate or professional school tuition and expenses.
A 529 college savings plan has no income restrictions for its contributors, and the yearly amount you can contribute to a qualified tuition program isn’t capped, as it is with the Coverdell.
However, any gift worth more than $13,000 (the annual IRS gift exclusion for 2011 and 2012) can trigger the gift tax, so it’s advisable to use the year’s gift exclusion as your contribution limit. That $13,000 amount is still substantially more than the Coverdell’s $2,000 maximum for 2012. Total maximum contribution limits for 529 plans depend on the specific program, but these limits are often set high into six-figure amounts.
As with the Coverdell, the more you save, and the earlier you save, the greater your benefits will be from a 529 plan. Earlier in this series, we used the example of a family saving $75 per bi-weekly pay period for 18 years for college expenses.
Let’s try doubling that, so that you and your spouse each save $75, for a combined bi-weekly contribution of $150. With a conservative, average annual rate of return of 5 percent compounded annually, your child will have about $112,500 to use for college expenses by the time he or she turns 18.
That’s $42,300 in earnings before fees, earnings that won’t be taxed if they’re used for qualified expenses. You also have the option of taking on more investment risk for a potentially higher return.
The 50 U.S. states, the District of Columbia and Guam sponsor 529 plans, often hiring financial institutions to manage these qualified tuition programs.
Guam’s 529 plan is called the Guam College Savings Program, and many states allow non-residents to participate in their plans. In a 529 plan, you can choose between different investment options, including investment management plans based on the changing age of your child.
As you look into 529 plans and other college savings accounts, pay close attention to the fees involved. Fees can vary widely, and higher fees leave you with less money in your account to grow and compound.
For more specific advice on your current financial situation, you can talk to a financial professional, who will help you compare options to find the account that will give you the best benefits.
Michael Camacho is president and chief executive officer of Personal Finance Center. He has more than 19 years experience in retail banking and with financial institutions in Guam and Hawaii. You can email him at firstname.lastname@example.org.