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There are many options out there for starting your child’s college savings plans. The 529 and Coverdell Education Savings Plans are the big education-focused options, and there are many options within each type of plan. Aside from choosing a plan, you must also decide how much you want to contribute, and what you will do with the plan if your child decides that college isn’t for them. Here, we’ll focus on the 529 Savings Plan, as it differs by state and type, and has both positive and negative characteristics as a savings plan. 529s can be a great plan for a family, so read on to find out if they’re right for yours.
There are usually two types of 529s offered in a state: a savings plan and a prepaid tuition plan.
A prepaid college plan is different from a savings plan because it allows you to pay for a college education in the future using today’s dollars and college costs. These plans allow parents to make contributions towards a set goal, e.g. four years of college, without having to focus on how much college will cost by the time the student is able to attend and how inflation will have affected the real costs of college. This can be an advantage because, according to an article on Forbes.com, college costs have been rising by roughly 7% per year, and they far outpace the rise in inflation. As well, if your income isn’t rising with inflation, this will allow you to fight inflation and make your savings worth more, comparatively.
Below, we compare a Prepaid Tuition Plan and a College Savings Plan.
|Prepaid Tuition Plan||College Savings Plan|
|Locks in current tuition prices||No lock on college costs|
|Covers tuition (some programs cover room and board)||Covers tuition, room and board, and supplies|
|Payment based on age of child||Most plans have limits of $200,000|
|Backed by state||No state guarantee|
|Age limits on beneficiary||No age limits|
|Most plans require the owner or beneficiary to be a state resident||No residency requirements|
|Most plans have an enrollment period||Enrollment is open all year|
The 529 Savings Plan is just that: a savings plan that you can contribute to throughout the year, which is guaranteed by either a state or financial institution. The advantages offered by a 529 Plan differ with each state. Some states offer better tax advantages if you put your money in in-state 529 plans, while other states, like Arkansas, actually offer a matching option where the state will match your savings up to a certain percentage. For the most part, all 529 plans offer some sort of tax advantage, you’ll just have to do the research with each state to know how much you’ll be able to write-off. To find out more about plans in your state, click here. Grandparents can also add to the 529 account, and reap the tax advantages on their own.
Another advantage of a 529 Plan is that you are able to contribute to it even if your child has already started college. Depending on which state you live in, you may be able to take advantage of your state tax break, and earnings on your savings plan investments will be tax-free if they are used to pay qualified expenses, such as tuition, books and fees. Since these investments are being made at the last minute, you may want to shield the investments in more conservative options (focus on yield, not growth).
Parents also retain control of the 529 Plan, meaning they get to decide where it goes if it’s not spent on the child’s college – this can differ from a normal savings account, which can be turned over to the child once they reach a certain age. The 529 is also a very stable investment, which is both a pro and a con. Income-investing is also a good way to put aside money for college – check out our Free Dividend Stock Tools to help you get started.
The lack of flexibility offered by 529s can be a detriment for those adding to the account. As the 529 is a college savings account, the money in the account can only be applied to education. If the intended child does not decide to go to college, the good thing is that the 529 can be rolled over for use by another member of the family. The negative side of this is that if there is no child to use the 529 for education purposes, you can withdraw it, but you must pay a 10% penalty on investment earnings, and the taxes on the contributions you were originally able to write-off.
Aside from the inflexibility for how this account is used, another downside is that the investment options are limited, and you give up control on where the money will be invested. Check your state’s plan guidelines to see if and how they guarantee your money, and also investigate performance, benefits and costs. Much like investing in a mutual fund, you’ll want to do all of the research you can to find out risk, return and fees. 529s are usually invested very conservatively, and you don’t get any say in which investments the 529 buys. So, on the upside the 529 is very safe and stable, and on the downside, its returns are very small. There are many other ways to pay for college and cut college costs, and you should look into these before deciding on a college savings plan.
There are both positive and negative aspects to the 529, and if you decide it’s not for you, luckily there are alternatives. Coverdell ESAs provide slightly more flexibility, but they usually have lower contribution limits; Roth IRAs provide more choice in investments, but they can be slightly trickier as they’re really meant as a retirement vehicle. There are also high-quality dividend-paying stocks to give you stable returns, but they are more vulnerable to market fluctuations and your level of equity will not be as stable as the 529. Make sure you do your research to help you decide which is the best investment for you.