529 College Savings Plans: What They Are & Why Your Kid Needs One

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Regardless of how you parent, there's a pretty good chance you're trying to do everything in your power to make sure your child has a better life than you could ever imagine. It's just something that comes with the whole mom territory, and it inspires us to help our children achieve their dreams. One place where that all happens is college, which begs the question: Are you saving for your child's academic future?

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While most moms and dads have every intention of putting away for their son or daughter's days at a university, sadly, many are not. The Wall Street Journal estimates that only 48 percent of families are saving for their child's college, which is a number that has been on the decline for years. With rising costs of living, unemployment, and job uncertainty, many don't know where to turn -- or what financial resources are available.

Here to help is millennial money expert Robert Farrington. Founder of TheCollegeInvestor.com, Farrington will demystify the 529 college savings plan, why it's important, and why families looking to save for their child's educational costs should consider one.

1. What the heck is a 529 college savings plan?

As Farrington describes, a 529 college savings plan is an investment option that offers tax-deferred growth and tax-free withdrawals on monies used for qualifying educational expenses. "Some states offer tax deductions for contributions to 529 plans as a way to encourage people to save for their child's college," adds Farrington.

2. Why should parents consider it?

Simply put, parents should consider opening a 529 plan because it's a great way to save for college. In addition to other outlets -- including paying for college out of pocket, student loans, and scholarships -- families should consider a 529 plan as another route to paying for college. "A lot of moms and dads are intimidated by the rising costs of college, so they think, Why save? I could never afford to pay the full cost. Anything that parents can afford to contribute goes a long way," says Farrington.

More from CafeMom: 8 Reasons to Start a 529 Savings Account STAT

3. Who can open an account? Do you have to be a parent?

"A 529 plan can be opened by anyone. It's for the benefit of someone to use for educational expenses," notes Farrington. In addition to parents, it can be grandparents, family members, and other loved ones who might open up a college savings plan for your child. "There is no age limit on [529] plans," adds Farrington.

4. How does the plan work?

In many cases, 529 plans are very similar to an IRA or 401(k). You can invest money in a variety of options like target date funds (which Farrington says are similar to retirement target date funds you can use in a 401(k), but focus on the date your child will start college), high-growth funds, savings accounts, and more.

"You put money into the plan (contributions), and then you can withdraw money at any time. If you're using it for qualified educational expenses, the money can be taken out tax-free. If you're not using the money for educational expenses, however, you can still withdraw the money -- but you'll owe taxes and a penalty on any gains you incurred. Your original contributions can always be taken out tax- and penalty-free," notes Farrington.

5. What are the benefits of having a 529 plan?

Aside from feeling awesome, parents who invest in a 529 plan give their money the chance to grow (tax-free) over time. It's estimated that families with a 529 plan can save 40 percent more each year for college, which is a pretty major plus. And let's not forget about the wonderful ability to use the money tax-free on qualifying educational expenses -- along with certain states allowing contributions to be tax deductible.

More from The Stir: 6 Smart Ways to Help Kids Save on College Tuition Costs

6. Okay, that all sounds great, but what are the setbacks to having a 529 college savings plan?

As with any investment, there's going to be some risk involved. "Historically, equities have risen over the long term, but short-term fluctuations could really harm a 529 plan. That's why 529 college savings plans should be considered a long-term investment," cautions Farrington.

In addition to the potential to earn and lose money in your investments inside a 529 college savings plans, parents should also consider the tax deductions and credits you won't be able to qualify for down the road. "Any money used to pay for qualifying education expenses out of a 529 plan cannot be counted on your tax return for the Tuition and Fees Deduction, or Lifetime Learning Tax Credit. For late savers, it might not be worth it to save in a 529 college savings plan, because the value of the tax credits could outweigh the benefits," mentions Farrington.

7. It all sounds good -- and I'm interested in starting a 529 plan for my kid -- but I don't have thousands of dollars to invest. Does it make sense to contribute?

No matter your current income, Farrington strongly urges families to begin putting something away for their child's future college costs. "By starting small and setting up a regular savings amount early, [your contribution] allows the money to grow and compound (earn interest and grow over time). That could add up to a sizable amount to pay for school," Farrington points out. Even if you only have $25 or $50 per month to invest, do it.

8. Are there any other ways to pad my child's 529?

"A great way to jump-start [saving for college] is to ask for gifts to the 529 instead of toys, or other things that children will never use," advises Farrington. Birthdays and holidays are the perfect time for you to ask friends and family to make a monetary donation to your child's 529 plan. It can be the gift that keeps on giving.

 

 

Image via David Franklin/Shutterstock

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