Families Get Major Tax Breaks for Education Expenses from State 529 Plans

By: Arman Rousta

If you are concerned about the rising cost of higher education, you are not alone. While today's price tags are not cheap ($110,000 for private colleges and $50,000 for public colleges), tuition is rising more than twice as fast as the rate of inflation, and parents of kids born today can face expenses of over $250,000 by the time their newborns are of age. No wonder why parents consider education savings to be the second most important financial goal, besides retirement savings. Despite the rising cost, the facts still stand that college graduates earn a lot more money than non-college grads (at least $1 million more over the course of a lifetime).

Thanks to newly enacted tax legislation called Section 529, saving for college has become a lot more manageable. This IRS tax code, first passed in 1996, states that investments in Qualified Tuition Programs (otherwise known as 529 plans) grow 100% federally tax-free, as long as the funds are utilized for Qualified Higher Education Expenses. Federal tax treatment is just one of the many benefits of 529 plans.

529 plans represent to higher education what 401(k) is to retirement. Most state 529 plans are managed by professional investment companies, such as Fidelity, Alliance, and Prudential, offer minimum investments of as little as $25 to open an account, and have generous contribution limits, over $250,000 in some plans. Although they have been around for over five years, only 25% of parents even know about 529 plans, and many state plans are still under development. That should change with the recent favorable legislation and the subsequent land grab that is presently taking place amongst major fund managers, brokers and investment companies.

Unlike 401(k), 529 plans can be opened directly by parents and families, without the involvement of their employers, much like IRAs. To date, there has been a lot of confusion amongst 529 account holders, due mostly to the misinformation that is being provided by banks, fund managers, employers, and the media. For those who have already opened accounts and subsequently learn about advantages in their own state's plan, balances can be transferred to new 529 plans once per year, but usually with some type of penalty applied from the original fund manager.

For those of you who need help saving for k-12 expenses before you worry about college, 529s are not appropriate, but there is another solution. Coverdell Education Savings Accounts, formerly known as Education IRAs, have recently been upgraded and made tax deductible for K-12 as well as higher education expenses. With private schools now costing over $10,000 per year, the $2,000 annual Coverdell limit per beneficiary can provide welcome relief. Unlike 529 plans, Coverdell accounts can be opened through almost all banks, and the only major restriction is for families that earn more than $220,000, who cannot contribute to Coverdells.

Between Coverdell accounts and 529 plans, families now have a more robust arsenal when trying to tackle ever-growing educational expenses. The key is to devise an attainable strategy and start while kids are still young. Saving through these new vehicles does impact a family's Expected Family Contribution when applying for Financial Aid, but not to a great degree. And you thought retirement planning was confusing? In sum, even with the promising new tax breaks, college savings and overall education financing is still a complex maze, which requires significant planning, resources, and attention.

To see which 529 plan is most suitable for your family, visit www.401kid.com.

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