Whether your goal is to cover the cost of college or pay for other educational expenses, advanced planning is key to ensuring you have the funds you need. Start early with a defined savings strategy to boost your savings potential and keep ahead of inflation.
529 plans are educational plans funded with after-tax dollars. Earnings grow tax-deferred, and withdrawals used for qualified K-12 and college expenses are generally tax-free. Although details vary by state, the basics are the same:
- Anyone can open an account for a beneficiary of their choice; they don't have to be a relative.
- Contribution maximums depend on the plan's specific limit and are subject to the gift tax.
- There are no age or income limitations on contributions or distributions.
There are two types of 529 plans: college savings plans and prepaid tuition plans.
College Savings Plans:
These let you build an education fund within an individual investment account. Money you contribute is invested in one or more specific investment portfolio(s) consisting of a mix of investments (typically mutual funds) chosen and managed by the plan's designated money manager. Navy Federal Financial Group offers college savings plans for each of the 50 states. Returns are not guaranteed.
Prepaid Tuition Plans:
These allow you to lock in today's prices, offering protection from future inflation, and are offered directly through your state. There are two types of plans: unit and contract. Unit plans allow you to purchase a percentage of units or credits and guarantees that the same percentage will be covered in the future. Contract plans (also known as guaranteed interest plans) guarantee a predetermined amount of future tuition expenses in exchange for lump sum or periodic contributions.
If you withdraw money for non-educational purposes, you'll generally pay income tax and a 10 percent penalty on earnings. Investment options are limited to those offered by the plan sponsor, and the ability to make investment changes is restricted.
Coverdell Education Savings Accounts
A Coverdell Education Savings Account (ESA) is a tax-advantaged savings vehicle that lets you save money for the qualified education expenses of a named beneficiary, such as a child or grandchild. These plans allow after-tax contributions of up to $2,000 per student per year for children until their 18th birthday. Contributions can be made by any person. Earnings grow tax deferred, and distributions are tax-free when withdrawn for K-12 or college education expenses prior to the beneficiary's 30th birthday.
Contributions are subject to income limits, and withdrawals are subject to taxes and penalties if the funds aren’t used for qualified expenses.
Education Tax Credits
If your child is enrolled in college, your educational expenses may earn you a break when it comes to tax time. There are two education tax credits you may qualify for: the American Opportunity Tax Credit and the Lifetime Learning credit. Tax credits are dollar-for-dollar reductions against taxes owed, making them more favorable than a tax deduction, which only reduces the total income on which your tax is based.
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