529 Plan

What is a 529 plan?

Basically, the plan works a lot like a Roth IRA. You put your money into a 529 investment account after you have payed taxes on the earnings. Then the gains are then tax-free. Pretty simple, right? Unfortunately not. However, weaving your way through the complications is worth it. Tax-free gains can mean an extra $25,000 for college. Will you spend a little bit of time for about $25,000?

Only states are qualified to offer the plans. (Universities can offer pre-paid plans, but those are riskier. Therefore, this I'm not considering them.) Each state has its own conditions and set of plans. You can sign up for any plan from any state. There are usually benefits to sign up for a plan in your state, but those benefits are typically outweighed by a superior plan elsewhere.

What are the advantages to the 529 plan?

• First and foremost, it allows my investments to grow tax-free. Tax-free growth is far from trivial. It will likely mean that your child gets about an additional 30% out of our investments for him or her.
• You can put your money in a low-cost plan that is aggressive and conservative at the right times. For example, when a child is just born, it will be a long time before he or she will need the money for college. Therefore, you can be more aggressive with the money. When it gets closer to having to pay for college is most prudent to have conservative investments so you can count on the savings. Most 529 plans will do both of these things for you automatically.
• If your child does not use the money, then it may be transferred to any family member for use in higher education -- even yourself.
• Qualified expenses don't just cover tuition, books, and other required study resources. They also cover room and board. Basically, all of the necessary expenses for going to college can be paid for with money from 529 plan. However, I not sure if beer is covered.

What are the disadvantages?

One major drawback is that if the money eventually needs to be taken out for non-educational purposes, then you have to pay taxes on it as if there were income in that year. An additional 10% penalty must also be paid. The only way to avoid that penalty is if your child gets a scholarship (although you’ll still have to pay taxes on the earnings). Source.

Another disadvantage is that it can affect the eligibility of financial aid. However, there is a way around that by making the plan owner someone other than the parent. You can do this by transferring ownership to a grandparent a year or two before the child enters college while leaving the child as the beneficiary.

How much can I contribute?

You can contribute as much as you want. However, a married couple can only write off up to $26,000 per year of contributions as gifts on their taxes. This can go up to $130,000 over five years. After that you are no longer able to write off your contributions. For a single person, the above numbers are $13,000 and $65,000 respectively.

Which plan should I choose?

Check out: best 529 plans.

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