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Invest in your child’s future with a 529 plan.

It’s never too early to start thinking about your child’s future. Whether you’re painting the nursery for your little one’s arrival or preparing your child for kindergarten, it’s probably a good time to consider a college savings plan. While college may seem far away, now is the time to start planning and a 529 Plan for college savings could help.

So, what exactly is a 529 Plan? It’s a state-sponsored, tax-advantaged educational savings account. There are two types of 529 Plans:

  • College Savings Plan – Similar to a 401(k) or IRA, you contribute funds to a mutual fund-type investment account, usually in an age-based portfolio.
  • Prepaid Tuition Plan – You can prepay some or all of the costs for an in-state public college education. There is also a Private College 529 plan which can be applied to private colleges.

Not every state offers a prepaid plan, and you’ll want to do some research and consult your tax advisor before you decide which type of plan is best for you. There are several advantages to a 529 Plan that make it a good college financing source.

1. Your withdrawals are exempt from federal income tax when used for qualified higher education expenses.

This is a great benefit when you consider other savings tools like mutual funds that get hit with a capital gains tax when you withdraw, as well as annual income taxes. Note that withdrawing money for students between K-12 the tax-free withdrawal limit is $10,000 per year. Make sure to refer to IRS Publication 970[PDF] to confirm this benefit is available when you start a 529 plan. Check to see if your state offers a tax break as well.

2. 529 plans do not have annual contribution limits.

However, contributions to a 529 plan are considered completed gifts for federal tax purposes, and in 2022 up to $16,000 per donor, per beneficiary qualify for the annual gift tax exclusion.

3. It doesn’t require much effort once you’re enrolled.

The management of the account will be handled by the investment company managing your plan. If you set up automatic contributions, you may not even notice the money you’re putting toward it.

4. You can pick a plan from a different state than you reside in.

Your state’s program might not offer the best benefits for your child. Make sure to research your options. Over 30 states offer a state income tax deduction or state income tax credit for 529 plan contributions. However, in most states you must contribute to an in-state 529 plan to be eligible for a tax break on your state income tax return. In these states, taxpayers who deduct contributions to an out-of-state’s 529 plan will be subject to taxes and possible civil penalties.

5. You have flexibility - because life isn’t always a straight line.

Depending on your plan, you may be able to change your investment options up to two times a year. You may also have the option of rolling your funds into another plan once a year.

Just know that the funds in your 529 savings plan can only be used toward approved educational expenses. 529 withdrawals for non-qualified expenses may face a tax penalty and withdrawal penalty. You’ll have to pay income tax and a withdrawal penalty of 10% on the earnings portion. Some states impose additional income tax penalty on earnings; exceptions to the penalty may apply. Refer to IRS Publication 970[PDF] for a list of approved expenses.

The benefits of a 529 plan make it a useful resource for parents saving for their child’s college. Are you ready to enroll? Find out what’s available in your state by visiting the College Savings Plans Network website or contacting your tax adviser.

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Commerce does not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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