What are the advantages of a 529 College Plan?
The 529 College plan is the single most effective and useful tool available to save for a college education. While the invested money is after tax, the tax free growth and tax exempt withdrawals make it a tool that you should not overlook. Of course, you still have to make contributions to make the program grow enough to pay for college, but using tax deferred growth over 18 years is an incredible advantage over taxed growth. Add this to the fact that the money is always controlled by the donor and the beneficiary can be changed at any time, and you end up with an attractive, powerful, and advantageous investment plan.
Let us first discuss tax free growth. In any investment vehicle, if the growth is not taxed, the overall return is increased. For example, if you are in the 30% tax bracket and the account grows by 10% in any given year, you would normally have to pay taxes on that 10% gain. This would reduce the overall net investment return to 7%. If you had that gain tax free, then it would remain at the full 10%. Now most people do not see it this way because they feel that the taxes are paid out of current cash flow and not directly out of the investment. Therefore, they feel it is not the same. But that type of thinking is short term. If you think this way, then consider allowing the 10% gain and then contributing the 30% taxes you would have paid as an additional contribution to the investment. When you think of the taxed gain from this perspective you will understand the power of tax free growth.
The fact that the money is always controlled by the donor is another very important advantage. Under this scenario the money will only be used for the beneficiary if the beneficiary goes to college. Under previous college savings programs the beneficiary received the funds at a certain age whether they went to college or not. In other words they would have a lump sum of money available to them to spend hoever and wherever they pleased, not just for college. The 529 program assures the donor that the money will be used as intended or the plan can be transferred to another beneficiary.
The control of the donor will also lead the donor to more aggressively invest than they otherwise would. Because the donor knows that they can withdraw some money in the event of a major emergency, they will be more likely to aggressively contribute to the account. If no emergency arises, the account will then be more likely to have enough money to pay for the college of the beneficiary. If it were not for this total control by the donor, the donor would be forced to mitigate cash flow risk by investing in other savings accounts. The more aggressive savings into the tax free growth of the 529 plan will benefit all involved and is a psychological advantage that cannot be overlooked.
This leads to the final primary advantage. Because the beneficiary can be easily changed then the donor can be assured that the savings will be used by someone who is going to attend college. If the original beneficiary does not choose to go to college the donor can switch to a sibling of the original beneficiary who may go to college. This flexibility will encourage the donor to save because they know that at least someone will be able to benefit form the savings plan. This type of flexibility was not and is not available in any other federally recognized college savings plan.
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