There are very few things that are certain in life, but here’s one to keep in mind: paying for college, almost without exception, is complicated. Whether you’re taking out student loans, participating in a work study program, receiving scholarship funds, or using money from a savings plan, you’ll have to fill out a lot of paperwork and make absolutely certain you understand everything you’re doing. For now, we’re going to focus on savings plans, since they’re one of the most universal parts of the experience. There are several different types of plans that vary in context and requirements, but we’ll talk about three basic options that are important to understand, and how they differ from each other. Hopefully, this quick guide will help you and your family decide what option will be best for you.
529 College Savings Plan
This is the first of two 529 savings plan options that you’ll read about, and it’s vital to understand the difference. First of all, a 529 plan, in general, is named for section 529 of the IRS (Internal Revenue Service) code, the part of tax law that makes the program possible. Section 529 exempted qualified tuition programs from being taxed in 1996. A 529 college savings plan allows your family to put money in an account that will go towards various college expenses. This part of the plan is easy, but the risk comes in with economic markets, because the value of your account will change depending on how the economy is doing. This makes a savings plan a bit of a gamble, but since the turn of the millennium, the plan has become more and more popular. The plan is almost always executed through mutual funds, including stock investments and bonds.
529 Prepaid Tuition Plan
A prepaid tuition plan is different from a savings plan in that, while the latter changes based on investment risks, the former freezes the costs of tuition as an investment at the prices that currently exist. This carries a different type of risk, because depending on the market value of college tuition, you could end up stashing away more money than you need, or not close to enough of what you need. You can execute a prepaid tuition all at once through a lump sum or you can add deposits periodically to meet certain goals through time. You’ll be either contracted through a certain length of time (giving the state time to invest your money), or sold a prepaid unit of time to add money to the plan. The options can seem confusing at first, but they’re similar in outcome.
ESA Savings Plan
An ESA plan is generally considered to be both more flexible and more potentially volatile than either of the 529 plans. It is more stringent in one important aspect, though: you have to name a beneficiary when you sign up for an ESA plan, and it is not possible to withdraw money from the plan once you deposit it, as ESA assets are non-revocable. The money cannot come back to you once you assign it to someone else. To make a full annual contribution to an ESA plan, your income must be below $95,000 (or $190,000 for joint filers). This is very different from 529 plans, which don’t have limits of contribution. If you breach the limit for an ESA plan, you’ll be subject to a tax on whatever excess you contributed. ESA plans are more independent, though, since you’ll largely be responsible for your own records and timekeeping for your deposits.
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