529s have become a popular choice for those looking to pay now and save later on secondary education. Here we break down the basics of education funds.
- 529s allow participants to buy tomorrow's education at today's prices and can be purchased with a single lump sum or series of payments. The state typically guarantees that the pre-payments will cover the future cost of education at a given state college. If the student chooses not to attend the state college, the state will often make available the amount of money equivalent to the cost of the state education at maturity.
State college savings plans have become more popular because of the investment flexibility and the possibility that proceeds may exceed the actual costs of education. While the contributions generally are not tax-deductible, the accumulation within the plans tax-deferred until withdrawn. Even then, the accumulations may be tax-free if used for qualified educational expenses.
Contributions to a plan may not exceed more than the amount necessary to provide for the qualified higher education expenses of the student. Qualified higher education expenses include tuition, fees, books, room and board, supplies, and equipment. There are no income taxes due on the value of 529s until the proceeds are distributed. Then, income tax is due only on the increased value of the plan over the contributed amount.
The taxes are calculated at the student's income. Some states even waive income tax on funds used for qualified educational expenses. If funds are dispersed and not used for qualified education expenses, a 10% IRS penalty may be due unless the disbursement meets special requirements. Stay financially fit friends.