Starting a savings plan for a child's college education can be a daunting task initially with so many avenues for setting up a savings plan that is somewhat flexible and yields a high return for your child.
The best advice is to start early and parents can initiate a savings plan as early as birth and grow the nest egg over many years. If you start early you can be gaining the advantage of interest on the funds in tax benefits which add growth to your plan. Instead of gifts for your child, relatives and grandparents can also contribute to your child's college fund.
For some a 529 plan makes good sense and can compliment the financial aid plans offered. For some parents they have multiple children that will attend college at the same time, and where the financial demand is doubled. A 529 Plan is a state educational savings plan which was established to help families save for future college expenses. If you follow the guidelines for the plan it can provide some federal tax benefits to you.
There are two categories of 529 Education plans and they are a savings plan or a prepaid plan and also some plans have a combination of both plans. Educational institutions can offer the prepaid plan only however you may purchase a plan with a Broker, a direct sold savings program, a prepaid contract or a prepaid unit/ guaranteed savings plan.
For instance with a New York 529 College Savings Program plan you would enroll with a broker and there are no state residency requirements and will accept contributions to a maximum of $ 358,496.00. Some traditional college education investors would argue that tax efficient mutual funds can yield higher returns and that with a 529 plan the costs outweigh the tax benefits.
The 529 savings plans do have a fee associated with administering the plan or a management fee. However there are reasons why a 529 plan are a better investment than some of the tax mutual funds. One is that some mutual funds will have year end capital gains that are taxable. Secondly, when you liquidate the mutual fund to pay for college education the appreciated value is also taxed.
Rising tax rates also will affect the rates on most capital gains on the long term are traditionally lower at only 5 % for income in the ten percent or fifteen percent tax brackets, and fifteen percent for everyone else. In the next three years, tax on capital gains is expected to rise to ten and twenty percent. As your child approaches college age a 529 Plan will reduce the equity exposure you have built up over the years without tax penalties. But with taxable mutual funds there is a tax on the built up equity unless you want to pay the tax to switch into another plan.
Finally the capital gains income can affect the financial aid eligibility for the next year which would disqualify your child for the need based financial aid. With a 529 plan there is no income to report when the distributions come out tax free and financial aid eligibility is still protected. The good news is that the costs of a 529 plan are dropping due to competition and contract renewal negotiations in the near future.
