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Basics of 529 Plans: How They Work

written by: Olivia Emisar•edited by: Michele McDonough•updated: 7/20/2011

As parents we want the best for our children and saving for their college education so they can have stability and financial security in their adult lives is something that makes the top of our priority list once that baby is born. Saving is hard, but 529 plan contributions can make saving easier

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    What Is a 529 Plan?

    The simplest explanation is that 529 plans are savings accounts specifically designed for parents to save for their children's future college tuition. A brief overview of the commonalities of 529 plans is as follows:

    • 529 plans are available in most states across the country.
    • You can contribute to ANY 529 plan available in the country.
    • Your child can attend ANY qualified college or university in the U.S., regardless of the state the plan is in.
    • The interest earned in 529 plans is not taxable.
    • States offer additional tax benefits that mirror federal tax guidelines.*
    • You control how the disbursements are made, not your kid(s).
    • There are no limit to how much you can contribute.
    • 529 accounts can be set up for anyone, including parents wanting to start or finish their college goals.

    * You can cancel the purpose of the account if your child decides not to go to college and you can also take money out for personal reasons. However, the interest earned will be taxable on the year of withdrawal as earned income and subject to a 10 percent tax penalty.

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    Compare Plans

    529 Every state that has a 529 plan offers different benefits, so it behooves parents to compare apples to apples when deciding which one to invest in. There are two types of 529 savings plans: Direct and Broker. A direct savings plans is managed by a plan manager and you, as an investor in the plan will have to research and understand all the options the way a financial advisor would. Every state monitors these plans but the investments are left in the hands of investment firms. These accounts have no fees associated with transactions.

    The broker accounts are managed by financial advisors and are subject to fees to compensate the advisors and pay for the sale of investments based on stocks or funds.

    You can choose a pre-paid plan that will allow you to save up for a specific amount of years worth of tuition or simply purchase one that allows you to purchase a certain amount of credits. The latter one may be beneficial if you or your child are only a few credits short of obtaining a degree.

    Please see the resource section to carefully examine your options on each 529 category and be able to compare the programs offered in every state. Your research needs to be specifically tailored to your current financial situation and the type of degree you will be saving for as well as the tuition cost of the chosen institutions.

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    Reducing Costs

    Studying When it comes to education, we need to look at the financial investment the same way a corporation looks at their bottom line—that is to get as much bang for your buck as possible. We need to avoid being overwhelmed by breaking the situation into manageable pieces that will allow us to work smarter, not harder. For instance, delegate part of the work and responsibility to the student. What is your student willing to do now to prepare for later? and what can he/she do?

    • Get excellent grades in school.
    • Attend a high school that offers Advanced Placement classes. These are college courses that earn them college credits while in high school at a fraction of the cost at the university. Depending on financial needs, students that meet the required GPA may have the cost waived.
    • Get their basic education in Math, English and Science requirements met in high school so they don't have to take remedial courses in college that cost money and earn them nothing by way of credits toward their degree.
    • Attend and graduate from community college first and go to a four-year university later.
    • Work part-time whenever possible and set aside a certain amount of their hard-earned money towards their 529 plan.

    Prospective students should be as vested in contributing to their future educational goals as their parents are to minimize the cost of their education and get a degree in a field they thought long and hard about. All the money in the world is not going to help them study, stay focused or have the drive needed to achieve their goals. They need to be vested and enthusiastic in order to succeed, and getting a share of the responsibility prepares them for the next steps into their academic future.

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    Free Is Better

    The federal government offers Financial Aid that in most states is sufficient to pay for tuition at community colleges if the student still lives at home. Grants also cover skilled two-year programs in culinary arts, dental hygenist, automotive and construction to name a few career choices. The government also offers loan forgiveness programs (attained through the federal government, not financial institutions) if the graduate commits to working in certain areas for a determined period of time. Some of the career choices include medicine and teaching careers.

    Free Button Consider programs at well-known universities that offer free tuition, housing and textbooks for free to qualifying families based on income. For instance, Stanford University offers all of this to families who earned a combined income of less than $100,000 a year. A family earning $60,000 a year is not expected to pay for anything and even those earning above the $100,000 level are eligible for financial relief that does not need to be paid back. Ivy league schools are not the only ones offering financial relief, community colleges and universities across the United States have instituted programs to attract students to their schools.

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    Please investigate free and reduce-cost options at the same time you make efforts to save for your children's education and allow your children to have some of the responsibility in researching and planning their future educational goals. They will appreciate their education and opportunities more when they have some measure of control in the decision-making process.

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    Resources

    Saving for College:http://www.savingforcollege.com/compare_529_plans/

    U.S. Department of Education: http://www.ed.gov/fund/landing.jhtml

    Stanford University: News; Stanford Report; February 9, 2010: http://news.stanford.edu/news/2010/february8/tuition-financial-aid-020910.html

    US News; Beter Yet, No Tuition; Emily Bradson; July 15, 2011: http://www.usnews.com/usnews/biztech/articles/060910/18free.htm

    Images: 529 By Mr. Matté [Public domain], via Wikimedia Commons; Free Button By Photostock /FreeDigitalPhoto.net; Studying By FreeDigitalPhotos.net