529 College Savings Plans have many tax and savings benefits, but few people use them.
There are behavioral and tax reasons why one should use a 529 plan, rather than keeping money in a savings or investment account. The behavioral reasons are that once the money is deposited in the plan, there are tax penalties for retrieving it, which keeps parents from doing so on a rainy day. While the penalty is relatively small (10 percent of the investment income), the deterrent works. In addition, the tax benefits to using a 529 plan are helpful to families. The investment gain on assets deposited into the plan is tax deferred and the withdrawals are exempt from federal income tax (like a Roth IRA) if used for qualified education expenses (ex. tuition and books). While contributions to a 529 plan are not deductible from the donor’s federal income tax (like the Roth), many states provide state income tax deductions for all or part of the contributions of the donor. This matters most to those in high tax states.
Not all 529 plans are created equal
Savings plans are more widely available than pre-paid plans, but not all are created equal and the West Virginia plan may be the best. Among all the 529 savings plans, annual fees range from about 0.3% per year to nearly 3% per year and investment options vary from low to high quality mutual funds.
If you would like to learn more about how to maximize the benefit of your contribution to your child’s 529 plan it is wise to check-in with an investment advisor who is knowledgeable about these plans. There are other considerations besides those mentioned in this article, such as how 529 savings affect availability of tuition assistance, how to retrieve the money deposited into a plan in an emergency, and gift and estate tax implications.