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529s are high on many parents' college-savings to-do lists as they are a tax-friendly way to save and grow money for college. But to reap the benefits of this now 10-year-old program, you have to be in the know. Below are my four tips for saving right with a 529:
1. Know Your Timeline
Remember that college isn't like retirement. Your timeframe for saving is much shorter than how long you have to build a nest egg – you're looking at definitely less than 20 years, even for the best money-planners out there. That doesn't leave you enough time to fully recover from stock market swings, so make sure that even if you have 18 years, don't put 100% of your money in the market. And if you have two to three years before the kids head off to the halls of higher learning, that's the time to go very conservative. Keep your funds in money markets or another cash equivalent that earns interest. The time to risk the market is kindergarten; the time to protect what you've got is when they're in high school.
2. Know the Rules
This isn't tax-free money you can spend on clothes or a vacation to the Bahamas. It MUST be used for educational purposes. Also, should you choose to manage your child's portfolio yourself, remember that the law allows you to change the asset allocation – from a moderate to a conservative mix, for instance – only once a calendar year. And remember, a withdrawal in February or October must be spent that calendar year. However, new contributions can be designated somewhere else.
3. Learn to Shop
The federal and state governments combined offer more than 80 kinds of 529 plans. So shop around and learn which one is right for you. You don't have to invest in a 529 in your state as each state abides by the same federal rules for tax-free earnings. But some have larger fees and different allocation rules. And more than 30 states allow you to take a state income tax deduction, up to a certain limit. Head to IRS.gov for more tax info. Like you tell your kids: It pays to study.
4. Over- or Under-Funded 529s
Finally, what if your 529 is worth less than the money you invested? Consider cashing out. No federal income taxes will be charged because no earnings were made. Or, at the other extreme: What if your child has graduated and the bills are paid. What to do with left over money? You can change the beneficiary of the plan, say to a sibling – though the same rules about only education-related fees still apply. If you're not totally sure your little one will be heading to college, you might want to consider saving in other investing tools than a 529.
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