Americans fling more than $30 million a day at 529 college savings plans, and no wonder -- the plans provide some sweet tax savings, a variety of investment choices and the satisfaction that you're doing something for the kids.
These plans allow savers to accumulate money their children use for college. Contributions don't get any federal tax breaks, though some states, including New York, offer tax incentives to participants. When the money is withdrawn to pay for qualified college expenses, it is not taxed.
Open a 529 plan for junior when he's little, feed it regularly, and you'll be happy to have a pot of tax-free savings when it is time to matriculate. (Keep the account in your name, and name your child the beneficiary, to avoid the funds hurting his financial aid eligibility.)
But here are some other ways to benefit from a 529 plan:
Buy one for a very short term. What if you are already in grad school and don't have a 529 plan? If you live in New York, which offers generous state tax deductions for contributions, you can put the money in a 529, collect the deduction and then turn around and spend it almost immediately on your next tuition bill.
Buy one without a particular use or person in mind. Maybe your child just finished college and doesn't know whether she will go to grad school or will have kids. So what? There's a decent chance she will do one or the other, if not both.
You can open a 529 for yourself and later name her or her progeny as the beneficiary.
The advantage to that? Short-term flexibility -- to use the money for yourself, her grad school or some future grandchild -- and really long compound interest.
Consider it a backdoor estate plan. Switching a 529 plan's beneficiaries to another generation can trigger gift and estate taxes, so you have to be strategic. In the case above, for example, if your account had grown to more than $14,000, you wouldn't be able to move all of it to a beneficiary in the next generation at once. But you could move $14,000 a year (indexed for inflation) to a new beneficiary without even starting to reduce your lifetime gift and estate tax exclusion.
Buy one for yourself. Your own 529 can pay for that midcareer MBA or classes you decide to take as you head into retirement.
- Buy 'em by the bunch. There's no compelling reason, other than simplicity, to have only one 529 - or even one per beneficiary. If you set up several, you can more easily switch beneficiaries on one or the other to accomplish those gift and estate tax objectives. And some plans are better than others for different reasons: You may choose to have one in your home state just to capture the full deduction and another in another state to get the best investment choices and lowest costs.
- Choose a successor beneficiary. If you own plans in your name but your children are beneficiaries and you die, your plan could go to your kids directly. That could hurt them when it comes time for them to apply for financial aid. Best to make sure your spouse is named in the plan as a successor beneficiary.
Do it yourself. As with other investments, 529 plans sold through brokers have hidden fees in the form of commissions and higher fund costs. If you do your homework -- hey, this is about education, right? -- and choose a good low-fee index fund plan sold directly, you'll pay less. Math 101: That can really add up.