529 plans: a good way to save for higher education

Use 529 plans for higher education and tax advantages

In 1996, Congress created 529 plans to encourage saving for future educational opportunities. It is a tax-advantage savings plan, legally known as “qualified tuition plan” that is typically sponsored by states, state agencies and/or educational institutions. The main advantage of a 529 plan is that the earnings are not subjected to federal taxes and generally not subject to state taxes when they are used for educational purposes.

Anyone can set up a 529 plan as well as name whoever they want as a beneficiary of the funds. There are no income restrictions and no limits on how many plans may be set up. Contributions to the plan cannot exceed the necessary cost for the educational expenses of the beneficiary. There may be gift tax consequences to the beneficiary if you contribute more than $14,000 per year.

There are two types of 529 plans: pre-paid tuition plans and college savings plans. Pre-paid tuition plans generally allow savers to purchase credits for future tuition. These plans may also be used to cover supplies, room and board expenses.  They are sponsored by state governments and have a residency requirement. Many state governments guarantee investments in their pre-paid plans. Michigan Educational Trust (MET) is Michigan’s pre-paid tuition program. 

College saving plans allows a saver to establish an account for a student for the purpose of paying eligible college expenses. Typically, an account holder can choose among several investment options for their contributions, where the plan invests on behalf of the account holder. These investment options include stock mutual funds, bond mutual funds and money market funds.  It also includes options of an age-based portfolio that automatically shifts toward more conservative investments as the beneficiary approaches college age. This plan is not guaranteed by state government and is not federally insured.

All the states sponsor at least one type of 529 plan and each is somewhat unique. Participants are not restricted to their own state’s 529 plans. Individuals are encouraged to shop and compare 529 plans from different states.

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