Last week’s blog looked at the use of Section 529 plans, specifically prepaid tuition plans, to provide a tax-advantaged way to help pay for college expenses. There are two types of plans – prepaid tuition plans and savings plans. This post will address savings plans.
This type of 529 plan allows you to put money away into an individual investment account and defer income tax on the earnings in the account. Money you contribute is invested in one or more specific investment portfolios. Each portfolio consists of a mix of investments (typically mutual funds) that are chosen and managed exclusively by the plan's designated money manager. You generally pick your investment portfolio at the time you open an account, or else one is automatically chosen for you. Your investment return is not guaranteed.
Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, supplies, computer equipment, software, Internet service and, generally, room and board) are income-tax-free for federal purposes and for some states as well, thus making the tax deferral a permanent savings.
The biggest downside may be that you don’t have direct control over investment decisions; you’re limited to the options the plan offers. Additionally, for funds already in the plan, you can make changes to your investment options only twice during the year or when you change beneficiaries. But each time you make a new contribution to a 529 savings plan, you can select a different option for that contribution, regardless of how many times you contribute throughout the year. And every 12 months you can make a tax-free rollover to a different 529 plan for the same child.
As you can see, each 529 plan type has its pluses and minuses. Whether a prepaid tuition plan or a savings plan is better depends on your situation and goals. If you’d like help choosing, please contact me at HZemel@BerdonLLP.com or your Berdon advisor.
Hal Zemel, a Tax Principal at Berdon LLP, New York Accountants, has more than 20 years in public accounting and advises businesses in the real estate, service, and manufacturing sectors.