Last updateTue, 19 Sep 2017 5pm

Business & Real Estate

5+2+9 could add up to college savings success

Next to retirement, college expenses are one of the most frequently cited reasons to save - and with good reason. Saving for rising college education costs is one of the biggest financial challenges Americans face.

While there are many investment vehicles designed to help you save for college, one plan in particular may be just what you're looking for. It's called the 529 plan, and it gives individuals the ability to save money on a federal-tax-deferred basis to help their children and/or other beneficiaries pay for qualified higher-education expenses.

So where does this plan come from?

Thanks to Section 529 of the Internal Revenue Code, states can offer these qualified tuition programs to help parents and others save for children's higher education costs. Among the 529 plan's benefits:

Tax deferral. Earnings from these programs grow federal-tax-deferred, meaning the beneficiaries who use the funds will not have to pay federal income taxes until they make withdrawals.

Flexibility. Funds from a 529 plan account can be used to pay for qualified expenses at any eligible school anywhere in the country.

Eligibility. Any U.S. resident can participate in any 529 plan and set up accounts for children, grandchildren, friends, even themselves. Unlike other savings plans, such as education IRAs, anyone at any income level can contribute to a 529 plan.

High contribution limits. The contribution limit on each plan varies by state, but most plans allow for contributions of at least $100,000, according to the College Savings Plan Network. While some states have created plans that allow initial contributions of as little as $25 per month, parents or grandparents are able to jump-start the plan with much larger contributions.

Estate planning benefits. Because the 529 plan account is treated as a completed gift for estate-tax purposes, individuals can contribute up to $50,000 in a single year (for married couples it's $100,000) without federal gift-tax consequences, provided no additional gifts are made to the beneficiary for a five-year period.

Control. Perhaps the best feature is that you control how your contributions are used. For example, if your original beneficiary opts not to attend college, the money can be transferred to a related family member without penalty. And if the money is not used for college, you can ask for a refund.

Keep in mind that the portion of the withdrawal representing investment gains would be subject to a 10% penalty and would be taxed at your tax rate.

You should keep in mind that contributions cannot be made to both a 529 plan and an education IRA in the same calendar year without being subject to a federal excise tax.

Each 529 plan has its own set of investment portfolios, as well as its own costs and fees. Keep in mind IRS rules prohibit investors from switching portfolios or investing in multiple portfolios within the same account. However, you can open separate accounts for the same beneficiary and choose a different portfolio for each account. Your financial consultant can discuss sound asset allocation principles so you can decide how best to invest your contributions.

If you're looking for a way to save for college, the 529 plan may offer a logical and versatile solution for parents, grandparents and, most importantly, children.

Steve Zeller is a financial consultant with A.G. Edwards & Sons, Inc., member SIPC, 379 Lytton Ave., Palo Alto 94301. The phone number is 326-5010.

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