Saving for Higher Education Expenses

If you are ready to begin saving toward the significant expenses of higher education for your children, it is time to consider college savings plans. The intent of this information is to focus on the intricacies of education savings plans rather than prepaid tuition plans, both of which are listed under the Section 529 Plan of the Internal Revenue Code. This particular plan sets aside money whenever possible throughout your income-generating years with ample tax advantages so that you have the proper funds available for your children when they are ready to leave for college or university.

College Students

College Savings Plan – 529 FAQs

In 1996, Congress passed a bill that included Section 529 for college accounts to provide parents of college-bound students with tax benefits if they save for higher education well before the time their children are ready to attend college or university. The dedicated contributions are allowed to be used toward various higher education expenses, including textbooks, computers, transportation, room and board, tuition, course fees and more. These funds can also be used for both undergraduate degrees and graduate degrees.

Keep in mind that several pros and cons exist in opening such an account. On the plus side, you will experience high limits of contributions, a wide array of qualifying expenses, tax-free earnings and state tax deductions. As for tax benefits, the growth of these asset accounts is not subject to state and federal income tax and most states offer tax waivers for any withdrawals on the account as long as they are used for qualifying expenses. The benefits often outweigh the potential downsides. It is important to understand such possible setbacks, such as having to claim the money as a gift each year, penalties if expenses are not qualifying, skyrocketing tuition rate increases and continuing variable market returns. It is also important to note that tax deductions will vary by state. And plan contributions are limited by the IRS and also vary by state.

One of the greatest benefits to these savings plans is that anyone is eligible to contribute to the account despite their annual income. Once an account owner has been established, which is typically the parent, you will have to assign a beneficiary. As long as the funds are spent on qualified expenses for educational purposes, the investment account will not be taxed. A 10 percent penalty is applied if funds are used for any non-qualifying expenses. If your child does not attend a higher education institution for any reason, you will be able to change the account beneficiary at any time, including to other family members and family members of the primary beneficiary.

Before you open an account, do not forget that this will affect financial aid and estate taxation. For financial aid, the account is considered an asset; therefore only 5.6 percent rather than 20 percent of other custodial accounts are taken into consideration. And because the gift tax applies, you have to limit contributions to $15,000 for individuals or $30,000 per couple each year per beneficiary to avoid paying gift taxes. Gift taxes can become complicated, so be sure to know what you are getting into with your annual contributions whether through this type of account or through direct contributions to the higher learning institution.

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