Saving for retirement isn’t the only major life event that you need to set money aside for. There are many other defining moments along the way that cost money—buying a house, opening a business and for many—your children’s education. The government offers the 529 plan to help you start saving for your child’s education early. It is a savings account that offers federal and sometimes state tax benefits while minimizing the impact of financial aid. The 529 plan was originally and still is mainly intended to address post-high school education, but you are also now allowed to put money into the plan for K-12 education costs. However you take advantage of it, make sure to avoid these mistakes on your 529 plan.
- Picking the wrong plan. Each state offers at least one version of the 529 plan, and depending on where you live, you may be eligible to take advantage of plans that other states offer. The good news is, in more than 30 states, your contributions to a 529 will result in a lower annual state tax bill. Picking the right plan means knowing what you want out of your 529. There are two main types: prepaid tuition programs and college savings plans. The former is offered by the state to be used at an eligible state school. It allows for the advance purchase of credits that will cover tuition for the beneficiary. College savings plans, on the other hand, can be used at any eligible educational institution, whether it is a public state school or a private school.
- Not understanding your plan. Via prepaid tuition plans (mentioned above), some states allow you to lock in tuition fees given that your child goes to a state school. However, be sure to read the fine print. Some of the states that make this guarantee do not necessarily guarantee your returns, which could leave you coming up short. States like Florida, Massachusetts, Mississippi and Washington guarantee tuition regardless if tuition growth overcomes your investment growth.
- Ignoring fees and penalties. The 529 plan is a type of investment plan, and with any investment there comes the chance for hidden fees and to incur penalties. The average annual fee for a 529 plan purchased directly from the state is 0.69 percent, according to the Financial Research Corporation. When purchased through brokers, the annual fee is closer to 1.17 percent. Keep fees in mind, as they can add up over time. Also be aware of penalties, which you can be subject to if and when you decide to switch plans. You can make a rollover into a new 529 without being charged a penalty only once per 12-month period.
- Not following withdrawal rules. Speaking of fees and penalties, these can happen if you do not withdraw funds from your 529 plan correctly. Money can only be spent on qualified higher education expenses. If you withdraw money before your child enrolls in college, you will pay taxes as well as a 10 percent penalty; however, if you wait until after he or she enrolls, you will not. Also, you are only allowed to take out a certain amount each year—the amount equal to or less than your child’s qualified education expenses for that year. If you take out more than you are allowed, then the excess will be considered taxable income, and you will be subject to a 10 percent penalty.
- Contributing later rather than sooner. With any investment account, the earlier you start contributing, the better. That’s because the earlier you contribute, the longer your money has time to grow and compound, which means more money to support your child when it comes time for he or she to enroll in college.
Avoiding these mistakes on your 529 plan can help you make the most of this savings account to ease the financial burden of paying for your child’s higher education.
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