Check out the 529 plan

Published 6:18 pm Friday, May 21, 2010

If you have young children, the end of another school year means you are now one year closer to the day when you send them to college – and one year closer to dealing with the high costs of higher education. However, you still have time to save and invest – and one of the best investment choices you can make is a Section 529 college savings plan.

In fact, a 529 plan contains, in just one account, some of the key advantages found in other attractive investment vehicles, such as a 401(k) or IRA. Consider the following:

Tax-advantaged earnings – Roth IRA earnings accumulate tax free and are distributed tax free, provided the account is at least five years old and the account owner doesn t start taking withdrawals until at least age 59. Similarly, a 529 plan s earnings accumulate tax free and are distributed tax free, provided they are used for qualified higher education expenses. (Keep in mind, though, that 529 plan distributions not used for qualified expenses may be subject to federal and state income tax and a 10 percent penalty.) Furthermore, your 529 plan contributions may be deductible from your state taxes. However, 529 plans vary, so be sure to check with your tax advisor.

High contribution limits – For 2010, you can put up to $16,500 into a 401(k) plan, or $22,000 if you re 50 or older. If you have an IRA, you can contribute up to $5,000 in 2010, or $6,000 if you re 50 or older. The lifetime contribution limits for 529 plans may be more generous. While the limits vary by state, many plans allow contributions in excess of $200,000, according to the U.S. Securities and Exchange Commission. Contributions to 529 plans are considered gifts; therefore, the $ 13,000 gift limit should be considered.

Asset allocation – One key to being a successful investor is choosing the mix of investments – such as stocks, bonds and government securities – that are appropriate for your risk tolerance and time horizon. A professional financial advisor can help you create a suitable asset allocation for your 401(k), IRA or other investment accounts. Most 529 plans also offer an asset allocation strategy, typically based on the age of the child or the number of years until college enrollment. For example, if your child is younger, your plan might start off with a higher percentage of aggressive investments in order to maximize your growth potential. As your child gets closer to college, the plan may take a more conservative approach to help reduce the effects of volatility before you start tapping into the plan.

Clearly, a 529 plan has much in common with popular investment vehicles, but it has other characteristics of which you ll want to be aware. For one thing, the financial aid impact: Assets in a 529 plan are considered an asset of the account owner, usually the parent. Federal financial aid formulas generally expect parents to use a smaller percentage of their assets for college funding. Consequently, you ll want to explore all aspects of any 529 plan, possibly in consultation with your financial and tax advisors, before taking action. But don t wait too long – your children will move from day care to dormitories in what seems like a blink of an eye.

This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.