If you know anyone with a child in college or one that will be soon, you know this is hand-wringing time, as families sweat admissions and financial aid awards.
For families with college costs in the future, it’s a reminder of the need to put aside as much as possible, else your child will someday leave school with a mountain of debt. Assuming you can afford to put money aside, what’s the best type of account to use?
Section 529 plans. Named for the federal law that makes them possible, these allow parents, grandparents — or anyone else, for that matter — to put aside large sums. There’s no tax deduction on contributions, but all withdrawals are exempt from federal income tax if used for approved purposes like tuition.
States set the maximum-contribution limits, but most allow a total of $200,000 to $300,000, sometimes more. Though 529s are set up by the states, most allow non-residents to invest, even if the student is not a resident either. In many cases, however, residents get a state tax break on contributions, investment gains or both.Among the most popular options are age-based accounts that emphasize stocks for young children and automatically shift to a safer mix of stocks and bonds as the college years approach. A 529 account is an asset of the person who sets it up, typically a parent or grandparent, so it does less damage to the student’s financial aid eligibility than most other types of college savings.
Unfortunately, shopping for 529s is tricky, and many families overlook the fact that they can lose money. There are sevreal options for college savers, though:
Education Savings Account. Often called Coverdell Accounts, ESAs offer tax-exempt savings and have many other similarities to 529s. However, ESAs can be used for qualified secondary-school expenses in addition to college. Unfortunately, contributions are limited to $2,000 per year per student, no matter how many accounts are set up.
As with 529s, federal income tax plus a 10% penalty are charged on non-qualified withdrawals. While 529s limit investments to those in official state plans, an ESA can hold just about any type of asset, much like an IRA.