Have any idea what a 529 plan is? If you aren't too sure, you have plenty of company.
According to a survey of more than 1,000 people conducted for financial services firm Edward Jones, nearly three-quarters of respondents didn't know a 529 plan is a college savings account.
The 529, named after Section 529 of the Internal Revenue Code, is a savings plan that offers tax advantages to help parents prepare for future college costs.
College-savings plans are sponsored by a state or a state agency; individual accounts are set up by a parent, grandparent or other adult with a child as a beneficiary. Account holders can select from an assortment of investment choices, from a low-risk savings account insured by the Federal Deposit Insurance Corp. to one that invests in stocks to increase the potential for a higher rate of return.
Earnings grow tax deferred and can be withdrawn free of federal income tax if they are used to cover higher education expenses such as tuition, books and room and board at an accredited college or technical school.
Despite the benefits, though, many families fail to save because they think they can't possibly put away enough money to pay for the ever-escalating cost of college .
But every little bit helps, says Lynne Ward, executive director of the Utah Educational Savings Plan, which manages more than $4.6 billion in assets.
"We have some families that are sending us $5 to $10 a month," she said. "Ten dollars a month isn't going to pay full tuition. But it could help pay for things like books and fees. We encourage families to save what they can, when they can."
As with any type of savings vehicle, the 529 isn't perfect.
The biggest drawback is the possibility that your child won't end up going to college. Any earnings accrued in a 529 account that are used for anything other than qualified education expenses are taxed on the federal level as ordinary income and subject to a 10 percent penalty. (If the beneficiary gets a scholarship, the penalty is waived on withdrawals up to the amount of the scholarship.)
That said, parents do have some flexibility, Salt Lake City Certified Financial Planner Sharla Jessop said. "If you set up a plan in one child's name and they don't go to college, you can transfer the account to another child and avoid the penalty," she said.
Even if no one in the family wants to go to college, it's important to remember that any taxes or penalties are assessed only on earnings, not on amounts directly invested in the 529 account. If you made $20,000 in contributions to your child's college savings account over time and it earned $2,000, your total account value would be $22,000. But if your child doesn't go to college, you would pay the taxes and penalties only on the $2,000 in earnings.
Another disadvantage is that account holders are limited to the investment choices of the plan and the fees charged by the agency that administers the 529 plan. High fees can eat away at any earnings. Some 529 plans have fairly high fees and limited investment choices.
But many 529 plans have a broad array of investment choices with varying degrees of risk and return designed to fit the needs of most investors and low to moderate fees.
To find a suitable 529 plan for your family, you may want to use Kiplinger.com's interactive tool at Kiplinger.com/tools/best-529-college-savings-plans. Remember, you are free to open a 529 account in any state you wish.
When a parent or grandparent sets up a 529 plan, they often are more likely to make regular contributions and less likely to raid it than they would a regular savings account. Did your television set go kaput? You may be less likely to buy a new one with money from your child's college savings account than with a regular savings account.
"You're dedicating in your mind that you are saving for a particular reason," Jessop said. "There's a mind-set that goes along with that. You're probably not going to get into (a 529 plan account) and withdraw money when you shouldn't."
Over time, that could mean more money for college and less debt for you and your child. And can make the 529 a powerful financial planning tool that you may want to take some time to get to know.