If you are thinking ahead for your future college student, then you have probably heard of the 529 plans. If you have not heard of these plans, or are interested in learning more about them, then you have come to the right place. Here is what you need to know about these plans and how utilizing both can be a great investment strategy to pay for college later down the line.
What are the 529 Plans?
These plans are intended to incentivize people to save for future education cost. They are sponsored by states, state agencies, education institutions, and are authorized by Section 529 of Internal Revenue Code. They offer specialized tax benefits that vary with the plan and the state you are located in.
The most basic breakdown of how the 529 Savings and the Prepaid Plans differ is to think of them this way. The 529 Savings Plan operates much like a 401(k), which enables the investor to select various options that are linked with securities like stock or bond mutual funds. The 529 Prepaid Plan is more like pension as the plan that is selected or the sponsor guarantees account owner’s return on investment. Typically, you purchase credits for future tuition, and once you have purchased them, even if the cost of college goes up, they still hold their value.
Why having both is a smart idea
Some savers may prefer one over the other. And it may also come down to what kind of plans you are offered that will influence your decision. However, consider for just a second why perhaps investing in both types of savings plans can help you make sure you do not get burned on your investment.
On the one hand, if you go with the 529 Savings Plan, then your investment is tied to the performance of the market. If the market ends up not performing well, then you can lose out on a chunk of cash. But if you have a Prepaid Plan as well, you could potentially make up for this loss through the increase in college tuition. Naturally, this assumes that tuition will indeed increase, but the trend has been an increase in the cost of college each year—decreases in college tuition can happen.
The drawbacks of these plans
You should make sure you read carefully what sort of restrictions come with your plan. According to the U.S. Securities and Exchange Commission, these plans may come with “certain pre-investment options. It is not permitted to switch freely among the options. Under current tax law, an account holder is only permitted to change his or her investment option twice per year or when there is a change in the beneficiary.” Moreover, to avoid taxes and penalties, you can only withdrawal this invested money to be used for qualifying higher education expenses or tuition for elementary and secondary schools. Make sure you understand the limitations of your plan before you commit.