Offered in all 50 states, 529 plans are often compared to three other savings strategies: custodial accounts (UGMAs and UTMAs), Coverdell ESAs (sometimes called "education IRAs"), and brokerage accounts. While most benefits are not unique to the 529, it has aspects that make it the talk of Wall Street when it comes to investing in kids' futures.
Gimme shelter Many families find the tax advantages of the 529 the most lucrative of all savings options. Earnings grow tax-deferred and qualified distributions, for items such as tuition and books at accredited universities, are federal tax-free.
IRAs also offer this tax shelter but only allow $2,000 in contributions before invoking a gift tax. The 529, on the other hand, allows contributions up to $12,000 annually ($24,000 per married couple, regardless of annual income) per beneficiary before such a tax is levied. And, unlike custodial accounts with identical thresholds for donations, contributors to 529s are allowed a lump sum bestowal of $60,000 ($120,000 per married couple) if no other donations are made to the same beneficiary in a five-year period. This provision is especially valuable in estate planning for grandparents who want to contribute to their grandchild's education. Additionally, many states offer their own tax incentives for investing in a state-managed 529. Check with your state to learn more about additional tax deductions, exemptions, and benefits, if any.
Whose money is this, anyway? Though brokerage accounts are fully taxable, they are considered a parental or donor asset. Some families choose this option to exploit a child's financial need. A 529 is also considered a parental asset and will not affect a beneficiary's need-based financial aid assessment.
What if a student's need or scholastic performance merits a full scholarship? Simply change the beneficiary on the 529, and a second child (or niece, nephew, grandchild, or family friend) has a growing college fund. Not only are there no relationship restrictions on 529s, there is no age limit for the beneficiary—adults who want to continue their education may have a 529 in their own name.
Passing the buck Another significant difference between the 529 and its predecessors is fund management. A 529 involves professional portfolio management by the institution your state's chooses. If you save for college any other way, you have to manage your own funds.
These arrangements suit different needs and appeal to different investors. You should understand the risks associated with all strategies before you invest.
State college savings plans may be very good savings strategies for some families, but before you invest, investigate. Remember that what's right for your brother-in-law isn't necessarily right for you.
If you've put off saving and your child is preparing for college soon, check out Nellie Mae's Tips for late savers.