Completing a college degree isn't cheap and tuition rates are likely to continue increasing to keep up with inflation. If you're already saving for retirement, starting a college savings plan for your child may be the next item on your financial to-do list. College savings plans, also known as 529 plans, offer several advantages to parents. If you don't have children yet, you can still set up a college savings plan for future education costs.
Choosing a Plan
All 50 states and the District of Columbia offer at least one college savings plan. A significant advantage to 529 savings plans is that they do not require you to be a resident of a particular state in order to invest in its plan. When researching plans, compare the minimum initial investment, the account fees, your available investment choices and the lifetime contribution maximum. How much you can contribute varies from state to state, with some state limits in excess of $200,000, according to the U.S. Securities and Exchange Commission.
Naming a Beneficiary
In order to name someone as a beneficiary of a college savings account, he must have a Social Security number. This means that if you are opening a 529 plan for an unborn child, you will have to name yourself as the beneficiary. Once the child is born and is issued a Social Security number, you can contact your plan's administrator to change the beneficiary. One of the benefits of a 529 plan is that you can change beneficiaries to another family member at any time, which makes it easy to transfer the funds if your child decides not to go to college.
529 Plan Advantages
College savings plans offer several advantages in terms of their tax status. You enjoy tax-deferred growth on earnings and qualified distributions are always tax-free. While there is no federal tax deduction for contributions to a 529 plan, your state may offer a deduction on contributions and/or an income exemption for withdrawals. The plans are flexible and you have the option of being able to make changes to your investment portfolio at least once per year. In terms of restrictions on contributions and withdrawals, 529 accounts are generally much less stringent than other types of college savings plans, such as a Coverdell Education Savings Account.
Any money invested in a 529 plan must be used to pay for qualified education expenses at an eligible educational institution. According to the IRS, qualified expenses include tuition, books, fees and room and board. The amount withdrawn for room and board must not exceed the school's estimated cost of attendance, and your child must attend at least half-time. If you take money out of a college savings plan for any other purpose, you are subject to a 10 percent penalty and the distribution is taxed at your regular rate.