Given that the cost of college has risen consistently over the few past decades, it’s not surprising to learn that the average federal student loan debt borrower today owes a whopping $37,338. If you want your child to avoid that fate, then you’ll need to do the best job you can of saving for college. The more money you’re able to sock away for your child’s education, the less they’ll need to borrow to fund their studies.
Now when it comes to college savings plans, you have choices. A taxable brokerage account gives you the most flexibility with your money. But you may want to consider a 529 plan instead. Not only do 529 plans give you some tax savings in the course of building a college fund, but thanks to a new rule, they can also serve as a retirement plan to some degree.
The upside of 529 plans
You don’t get a federal tax break on the money you contribute to a 529 plan (though some states offer their own incentives). However, investment gains in a 529 plan can be taken tax-free. And withdrawals are tax-free provided that money is used to pay for qualified educational expenses.
To be clear, 529 plans are no longer limited to college. You can use a 529 plan to pay for a private elementary or high school if you do choose. But if you’re specifically trying to build a college fund, then you’ll want to reserve that money and not take withdrawals for education along the way.
Now the downside of funding a 529 plan is that withdrawals for non-educational expenses are subject to taxes and a 10% penalty. That penalty only applies to the gains portion of your account, not your principal contributions, since those go in on an after-tax basis. But still, that 10% penalty is enough to deter some people from saving in a 529.
