Summertime ushers in lazy weekends at the beach, backyard barbecues, and vacations to visit grandparents. While your kids may be young now, they will grow quickly – and so will those college expenses.
Families with older children are finding college tuition bills in the mailbox for the fall semester.
If you're a parent, don't be deterred by common misconceptions about 529 college savings plans; they can serve as a valuable vehicle to build an education nest egg, which can help you avoid tuition sticker shock later.
A 529 college saving plan is simply a way to save and invest for college costs with tax-deferred earnings growth and tax-free distributions. Some states offer a tax benefit for contributions as well.
Planning for the future education of children can be a daunting task, given the demands of raising a family.
"My best advice to young clients is to start small and start early. The time will go quickly, but if young parents take the necessary small steps early on, they stand a much better chance of reducing some of the stress of the tuition-paying years. The gift of graduating a student with little or no debt is one that he or she will reap the benefits of throughout their life," says Robert Solimano, certified financial planner and owner of Angel Oak Financial Services in Montvale, New Jersey.
College costs are continuously increasing. "By saving now and investing funds, they will benefit from the growth available to help pay for college. Most aid comes in the [form] of loans with low rates, not grants. With the average loan at graduation being around $35,000, it is better to save than take out loans," says Dawn Brown, certified financial planner and senior financial advisor at Altfest Personal Wealth Management in New York.
The rules about purchasing a plan and using the money can be complicated. Let's take a look at some of the common misconceptions.
You are limited to your home state's plan
False. Plans are not limited to your home state, but some states offer a tax advantage if you reside in a state where it is administered.
"Certain states offer a full or partial tax deduction or tax credit. Not all states do, so if your state does not, you may want to venture out to then look for the best-rated plan you can find, which may or may not be in the state you reside," Solimano says. Use the U.S. News & World Report 529 Finder to screen and rate different 529 plans.
Your contribution limits are the same as an IRA account
False. Each 529 plan sets its own maximum contribution limit. For example, California's maximum contribution for the same beneficiary is $475,000, while the maximum contribution limit for New York is $375.000. For IRS tax purposes, 529 plan contributions are considered gifts, says Melissa Sotudeh, certified financial planner and wealth advisor with Halpern Financial in Rockville, Maryland.
"The IRS limit for tax-free gifts to a child is $14,000 per year per person or up to $70,000 over five years," Sotudeh says.
The account must be in your child's name
False. The child is listed as the beneficiary, and it is the account owner who has control over the account, Solimano says.
"This is important, as it is one of the few circumstances where the gift giver is still in control of the gift that was given. The college years may be some time in the future, and a child's plans or intentions may change as time goes on. The account owner's control provides peace of mind to those funding the account," Solimano says.
There is some flexibility. "When my two sons were of college age, the younger son's 529 portfolio had outperformed the older son's. The older son's private school tuition was significantly more than his younger brother's state college tuition. Through the flexibility of beneficiary changes, we were able to use gains that little brother had to help out big brother," Solimano says.
Your income is too high to contribute to a 529 plan
False. There is no income limit to contribute to a 529 plan, says Tyler Landes, founder of Tandem Financial Guidance in Kansas City, Missouri.
"Even super-high earners can help a beneficiary with education expenses and many times receive a state tax deduction," Landes says.
You could lose the money if your child doesn't go to college or gets a big scholarship
False. In the event your beneficiary does not need all or any of the 529 funds, you can reassign the beneficiary to another family member for his or her use without penalty, Landes says. "This can be a sibling, cousin, niece or nephew. If instead you'd like the money back, you can change your mind and withdraw the funds. You'll incur a penalty of 10 percent on the accumulated earnings in the account, but you'll get back any remaining principal intact," Landes says.
A 529 plan will hurt your chances at receiving financial aid
It depends. For the purposes of financial aid, a 529 plan account is considered an asset of the parent, Landes says.
"While this does factor into the expected family contribution, parental assets are not as big a factor as the student's assets. Generally speaking, not having saved enough for college is a greater risk than receiving less financial aid. If you can afford to be financially prepared, that's the best option," Landes says.
All 529 plans are the same
False. "Selecting a plan for maximum benefit means finding the right mix of tax savings, low fees and strong investment options," Landes says.
While the college years may seem far off, they will be here in a few blinks of the eye. "Parents appreciate the low entry point for contributions and the automatic investing features. The hardest part for them is realizing they can actually afford it and simply getting started," Solimano says.
The gift of college savings can go far beyond the dollars and cents in the account, Solimano says: "From an intangible perspective, the act of simply doing all that you can through proper concern and planning creates a level of comfort and satisfaction that is worth more than any tax deduction or credit could ever provide."
Read the original article on U.S. News & World Report. Copyright 2016. Follow U.S. News & World Report on Twitter.
