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Saving for College: What Is a 529 Plan and How Can It Help You?

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The secret is out: College is really expensive and it's only getting worse. According to a study by Wells Fargo surveying 1,414 millennials between the age of 22 and 32, over half of them reported using student loans to pay for their college education. If you are a parent, you should be thinking about ways you can save for your child's college education to help him or her not be burdened by student debt.

Finding the right college savings plan takes some research and simply putting money into a savings account may not help you reach your goal in time. There are several options available, but a good one that is certainly worth considering is using a 529 plan and below is some more information about this type of account:

What Is A 529 Plan?

It is a college savings account specifically designed to pay for educational expenses. Your investments are already taxed (similar to a Roth IRA), but if you withdraw your money early or use it for something other than to pay for college expenses, you will have to pay a penalty fee.

Which Plan Should I Choose?

There are two types of 529 plans: savings and prepaid. As with anything, there are advantages and disadvantages to each plan. Knowing what each plan offers will help you make a decision that is best suited for your educational financial planning.

529 Prepaid Plan

With a prepaid plan, essentially you are purchasing tuition credits for a university within your state, at today's price. This will exempt you from needing to deal with tuition increases in the future, but you must be confident that your child will attend a specific school. A prepaid plan covers the cost of tuition and mandatory administrative fees, which does not compare to the full coverage of the savings plan that allows you to cover most college related costs. Also, this plan is only eligible with the 270 colleges and universities that are participating right now.

529 Savings Plans

A 529 savings plan can be used to pay for tuition, mandatory fees, room and board, books, and computers, all costs that can add up very quickly upon a student's arrival on campus, especially if they are attending an out of state school. A savings plan does not have location limitations but at the same time, you will not be eligible for frozen tuition prices. Some would argue this plan is not as financially helpful because you still have to deal with the rising costs of a college education. However, all of your expenses related to school are eligible, which is a helpful feature of the plan and you can choose between several investment options so your money can also grow in earnings.

Applicable Fees and Taxes

When deciding between a savings or prepaid plan, you want to research fees for each plan. Some might include an application cost, management, annual, or administrative fees. Keep in mind however that a prepaid plan usually does not have as many fees especially because investors are not charged for account management fees.

You can also get tax deductions and credits for 529 plans in certain states. Those states are: Alabama, Arizona, Arkansas, Colorado, Connecticut, District of Columbia, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maine, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, and Wisconsin.

For more information, take a look at NerdWallet's summary of the best 529 plans by state.

Contributions Limits

It doesn't matter which plan you choose. Whether you select a savings or prepaid plan, each person can only contribute $14,000 per beneficiary. If you have a spouse, you can invest an additional $14,000 on their behalf. As time goes on, the account is not able to exceed $360,000 in actual contributions, but the total amount may continue growing past this amount in investment gains.

Whether you choose a savings or prepaid 529 plan, you will be glad you put money aside for a beneficiary's college expenses. Many also like to consider using a Roth IRA so when choosing between the option of using a Roth IRA vs. a 529 Plan, just make sure you have done your research to see which options is better suited for your needs. Tuition costs are only going to rise over the years, so by investing in one of these plans, you are creating a more secure future for your beneficiary that will mean they have less money to take out in student loans.