Many financial advisers advise parents to save at least 6% of their income to be sure to have enough when college time arrives. With a time frame of 18 years many parents feel anxious if they are saving enough for college. Many smart parents have even decided to start saving for their child's college even years before the child is born. That's what I call good savers.
If you are a good saver you probably know about how 529 college savings plans can help you to meet your goals. These state sponsored savings and investment plans are set up with an asset management company to administer the investments and monthly deposits. Usually the parents are the owner of the account and the child is the beneficiary.
The benefits of a 529 plan
- The account owner does not pay current income taxes on the unrealized gains in the account.
- The owner/parent, not the child/beneficiary, always has control of the account.
- If the beneficiary/child doesn't go to college, the account can be used for another family member or other individual.
- Anyone can contribute to the account. There are no income limitations.
- Most states have no age limit for when the money has to be used.
The best quality of a 529 plan is the tax benefits. While invested, the the growth and investment gain is tax-deferred. Second, when withdrawls are used for qualified higher education expenses, the income is tax free.
If the money in the account is no longer needed for college (because the child gets a scholarship, doesn't go to college, etc) then the account owner can withdraw the unused money. When withdrawals are taken for non-qualified distributions, the earnings are taxed at ordinary income tax rates and there is also a 10% penalty on the investment earnings. The taxes and penalty are not assessed on principal.