College tuition costs continue to rise at an alarmingly steep pace, and many families are blown away by the sticker shock associated with a four-year degree program. As a financial advisor, I work with clients with young children (and grandchildren) to carefully evaluate the pros and cons of saving money into a 529 plan to pay for future college expenses. A 529 plan is an investment account that offers tax benefits to pay for qualified education expenses.
A 529 college savings plan offers several key advantages for today’s younger generations and families. Some of the key benefits include the following:
- Tax-Free Growth
As long as distributions are used for qualified higher education expenses, the growth portion inside the 529 plan is eligible for tax-free distribution. However, if non-qualified distributions are taken, the growth portion of the 529 plan is subject to ordinary income tax, plus a 10 percent penalty.
- Tax-Free Return of Principal
You can always take out what you’ve contributed to a 529 plan (i.e., basis or principal) without taxes or penalty. The ability to do this tax-free is a key benefit to individuals and families that may find themselves in financial hardship without access to other sources of liquidity. It’s also an important consideration for families that think scholarships are a likely scenario for their child(ren).
- Pay Off Student Loans
Up to $10,000 can be distributed to pay off student loans – this is a relatively new 529 plan benefit, which gives account owners the ability to use $10,000 from within the 529 plan to pay down student debt.
- Funds Can Be Rolled Over or Consolidated
Money in a 529 plan can be rolled over and/or consolidated into a 529 plan for qualifying family members. Eligible family members include spouses, siblings, children, aunts, uncles, nieces, nephews, and first cousins. Rolling over funds to a family member may be a great source of flexibility, particularly if the original 529 plan beneficiary chooses not to go to college.
- Compounding Investment Returns
The younger the 529 plan beneficiary, the more significant the potential impact of time and compound investment growth. Starting a 529 plan early is a fantastic planning opportunity since it creates more time for the account to grow on a tax-free basis.
- Tax Benefits Differ by State
Some states offer income tax benefits (e.g., deductions and/or credits) if contributions are made to the owner’s state-sponsored 529 plan. Depending on your primary state of residence, this may or may not be an important reason for utilizing your in-state 529 plan.
Financial situations vary from person to person and family to family. Therefore, saving for short-, medium-, and long-term goals should be based on a series of decision factors and priorities. There is never a one-size-fits-all approach to achieving goals, and it’s for that reason that we work with clients to help them outline a roadmap and plan to help increase the likelihood they will be able to fund their goals.
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Investment Advisory services offered through Birchwood Financial Partners, Inc. an SEC Registered Investment Advisor.
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