But plans are administered by each individual state, and the plans may not offer an attractive investment opportunity, depending on which plan you choose.
For example, some state plans may offer only high-cost funds or a limited selection of funds. For those with investment expertise, that can be a significant downside over investing the money in more attractive things such as individual stocks.
It may be even worth paying taxes in a taxable account to be able to invest in these other options. I would rather have the flexibility of a brokerage account and its investment options than the state tax benefits of a For those without the expertise to pick their own investments, however, the limited options may be acceptable and even preferable.
State plans are literally and figuratively all over the map. The plans may also differ by the kinds of investments you can make, the costs of those investments, minimum contributions and how the plans are administered more generally.
The rules on plans are strict. The most important one is this: you must use funds in a account to pay for qualified educational expenses. Qualified education expenses include tuition and fees, room and board as well as textbooks. They may also include other expenses for attending college such as a computer and software used primarily for the classroom. So this extra withdrawal would incur regular taxes plus the bonus penalty, even though the parent had every intention of using it for qualified expenses.
Some lower-income families may be just as well off to save in a regular taxable account as in a plan without the restrictions.
College is expensive enough without doing things that minimize the amount of free money that you can receive. And a plan can count against you in the calculations that determine your eligibility for aid. It could get worse if another relative owns the account , though these rules are in the process of changing.
Fees may be higher than they otherwise would be if you had a wider selection of options — another part of the downside of limited investment options. Your state plan may offer only relatively high-cost ETF index funds, for example. And with low-return options such as bond funds, a higher expense ratio can really hurt the total return. These funds charge an expense ratio as a percentage of the amount you have invested in them.
Higher-cost funds might charge you 0. That might not seem like a lot, but low-cost funds today are priced under 0. Unlike other savings plans, such as a Roth IRA or Coverdell Education Savings Account, plans have no annual contribution limits and high aggregate limits. You can invest in almost any plan , no matter where you live or where you child will attend college. However, there are exceptions to the penalty if the beneficiary gets a scholarship, attends a U.
Military Academy, dies or becomes disabled. A plan account owner must select from a menu of investment options offered by the plan. This typically includes static investment portfolios that aim to achieve a targeted level of risk, individual fund portfolios and age-based portfolios that automatically shift asset allocation as the beneficiary gets closer to college.
It's simply important to remember that you don't have to save and pay for all their college. Plus, there are tons of ways for them to find help paying for school, from finding scholarships , to getting student loans. Here's our guide on how to pay for college. Let's see how that breaks down. If you want better estimates, check out our Plan Guide By State , find your state, and see what the costs to go to college are in your specific state. Fidelity also has a great free calculator that allows you to determine how much your need specifically for your situation.
You might also find this plan contribution limit guide helpful. This is a huge range, no doubt. But remember what "low end" and "high end" mean.
The low end amount is for someone that wants to help their child pay for a public 4-year school. The high end amount is for someone that wants to fully pay for a 4-year private education for their child. Parents should also remember that, even when saving for private school, many students who attend private schools get discounted tuition, or receive scholarships to offset the "real" tuition price. So, even that high end number might not make sense when saving for college. What many people don't realize is that you can invest in almost any state plan.
For some people, it can make sense to use your own state's plan to take advantage of the tax deduction - but not all states offer tax deductions on contributions notably California.
If the state doesn't matter, the next things to look at are performance and ease of saving. For performance, you want good performance for low fees. For ease of savings, we look at whether the plan can be connected to savings programs like College Backer. Check out this guide here, find your state, and see what plan we recommend: Plan Guide.
But it can be daunting for a first-time saver and sleep-deprived parent to sort through the many different options, rules, and tax angles that these accounts involve. In this article, we explore the basics of plans and highlight some of the risks you should aim to avoid. A plan, more formally known as a qualified tuition plan, is a way to save money to pay a child's or other family member's education expenses.
The "" comes from Section of the Internal Revenue Code, which allows for contributions to grow tax-deferred and to be withdrawn tax-free if you use them for qualified educational expenses , such as tuition, room and board, and required fees.
All 50 states and the District of Columbia offer at least one plan, and most provide a tax deduction or credit for contributions to their plans and some even allow a deduction if you contribute to another state's plans. The federal government offers no upfront tax deduction but won't tax your withdrawals if, as mentioned, you use them for expenses that qualify. These are what most people think of when you mention a plan. They were originally designed to pay only for post-secondary education costs, such as college tuition.
But in , the Tax Cuts and Jobs Act expanded them to cover certain costs associated with K education. While the states sponsor plans, they may delegate the actual management of the money to large mutual fund companies and other professional investment firms.
Most states offer a menu of different plans that invest in different types of securities and vary in risk accordingly. For example, a plan that invests in stocks may have greater growth potential but be more volatile than one that invests in bonds or a mix of stocks and bonds. When you open your account you can decide which particular plans to invest in and divide your money among several if you wish.
You can also move money among accounts later if you want to. The other type of is the prepaid tuition plan , which allows you to pay for future tuition at today's prices at participating colleges and universities. These plans are also generally sponsored by state governments.
But unlike education savings plans, the prepaid plans don't cover room and board, and you can't use them for elementary or secondary school. There are risks to consider with either type of plan.
If you're just getting started in saving for a child's education, it can be tempting to toss some plan brochures into your bottom desk drawer and bookmark a few websites to worry about later.
Putting it off is the first and probably biggest risk you face. College costs tend to rise much faster than most other things. That means the price of tuition can double every nine years. So the sooner you can get started, the better. Any money you invest in your child's first year will have 17 or 18 years to compound, on a tax-free basis, by the time they're ready for college.
Your employer may offer a similar plan through payroll deductions. The more automatic you can make your savings, the less you will have to think about it and the more money you're likely to accumulate over time. While this isn't as much of a problem as it was in the early days of plans, some states' funds don't perform as well as others.
Some also have higher expenses. Either or both of those can be a drag on the growth of your balance. If your state offers you a tax deduction or credit for your contributions, one of its funds may still be your best bet, even if its performance lags a bit or its expenses are a little higher. But bear in mind that you don't have to invest with your own state and are free to shop around.
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