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Saving for college: Money grows tax-free with 529 plan

by Catherine Holland

GMAZ interview by Kaley O'Kelley

Posted on June 18, 2012 at 6:50 PM

Updated Monday, Jun 18 at 7:08 PM

PHOENIX -- Struggling with state budget cuts, public universities throughout the country have been raising tuition and fees.

Some states, including Arizona, are hiking tuition and fees more than others. In April 2011, the Arizona Board of Regents approved an increase of 22 percent for in-state undergraduates at University of Arizona, 19.5 percent at Arizona State University and 15 percent at Northern Arizona University.

"Increases in college prices for the 2011-12 academic year reflect the continued impact of a weakened economy as well as state funding that has not kept pace with the growth in college enrollments," reads the College Board report "Trends in College Pricing." "For the fifth consecutive year, the percentage increase in average tuition and fees at public four-year colleges and universities was higher than the percentage increase at private nonprofit four-year colleges."

The bottom line is college costs more than ever and the time to start saving is now.

Scholarships are an option, but they might not cover everything. Financial expert Dean Wegner suggests you look into establishing 529 plans for your kids. Created in 1996, a 529 plan is basically a special tax-deferred savings account that's meant to help families set aside money for college.

"You put money in it monthly and it grows over time," Wegner explained. The idea is that by the time the child is ready to go to college, the money will be there -- ready and waiting. Wegner said it's never too early to start.

"You don't even have to have kids to set it up," he said. "You can change the beneficiary [as long as it's a family member] at any time. … As long as it's for higher education, you can use it for whoever you want."

The money can be spent on a variety of education-related expenses -- tuition, room and board, transportation, computers, books and more.

These 529 plans are state plans and each state has one. That does not, however, limit where you can spend the money.

Each state's plan is a little bit different and you can have 529 plans from more than one state.

"If you pick Arizona, when you put the money in, you get a tax credit back on your state income taxes," Wegner said. "So, there are two credits -- the tax-deferred at the end, and then every year, the money that you put in, you get a credit back on your state taxes as long as you live in Arizona and you have an Arizona plan."

Arizona offers three 529 plan options. The ones managed by College Savings Bank and Fidelity Investments are direct-sold. The plan managed by Waddell & Reed is advisor-sold.

The contributions to a 529 don't have to be big. The minimum is $15 per month. The maximum is $13,000 per year.

"A good target is going to be $200 a month," Wegner said.

While not required, he also suggests starting with a lump sum of $5,000, if you can. If you do the $5,000 down and $200 per month, you should have a little more than $80,000 after 15 years. "All that money is tax-free or tax-deferred," he said.

But that's not all. That 529 money is protected.

"It is a qualified account, so it's exempt from bankruptcies, judgments, any of that nasty stuff that can happen 10 years down the road."

If it turns out you don't need the money for higher education, you can withdraw it, but it will be subject to state and federal taxes, as well as a 10 percent penalty on earnings. There are some exceptions to that penalty.

Wegner doesn't just talk up the 529 plan, he himself has two for his kids.

"I believe in it. I've done all the research," he said. "I don't really see any downfalls. I think it's a great program."

To learn more about 529 plans, visit SavingForCollege.com.

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