If you are a California parent or grandparent who wants to help pay for your children's and/or grandchildren's future college expenses, you may wish to consider setting up a 529 plan for each of them. Per the U.S. Securities and Exchange Commission, a 529 plan is a college savings plan that benefits your child or grandchild while giving you tax advantages.
Each state sponsors its own plan, but you also can choose among those sponsored by state agencies or educational institutions themselves. 529 plans come in two varieties: prepaid tuition plans and college savings plans. Each has its own advantages and disadvantages.
Prepaid tuition plans
States usually sponsor their own prepaid tuition plan, which has a state residency requirement for you and/or your beneficiary. With this type of plan you purchase credits at the higher learning institutions that participate in the plan, most of which are public in-state institutions. Be aware that these plans normally do not cover your beneficiary’s room and board.
The federal government does not guarantee prepaid tuition plans; some states do, but others do not. You could lose part of your investment if the institution your beneficiary attends experiences a financial shortfall or if (s)he chooses to attend a college or university that does not participate in your plan.
College savings plans
A college savings plan gives you and your beneficiary more options and flexibility. With this type of plan there usually are no residency requirements and your beneficiary can attend the U.S. college or university of his or her choice and even some non-U.S. institutions of higher learning. In addition, plan funds cover not only tuition, but also fees, room and board.
You can choose from a variety of investment types including the following:
- Mutual funds
- Exchange-traded funds
- Principal-protected bank products
The federal government does not guarantee college savings plans, nor do the states that sponsor them. The FDIC may insure some of your investments, such as some principal-protected bank products.
If you choose a state-sponsored plan, your contributions to it are not subject to federal income taxes and likely will not be subject to state income taxes either. The earnings your plan accumulates likewise are neither federally nor state taxed. However, should you and/or your beneficiary use plan proceeds for anything other than obtaining a qualified higher education, plan withdrawals will be subject to both federal and state income taxes, plus an additional federal penalty of 10 percent on earnings.
You should consult an experienced tax attorney and/or tax advisor before investing in any 529 plan. This information is educational in nature and should not be interpreted as legal advice.