With the cost of education increasing, saving for college has become more necessary than ever. One of the best ways to do this is by opting for a 529 plan, which is a savings plan that not only offers financial aid but also provides tax benefits. There are two types of 529 plans that you can consider: prepaid tuition plans and college savings plans. The good part is that nearly every state has a 529 plan in place, and even some private colleges and universities offer this plan.

Here are the basics that you need to know if you are planning to start saving for college for your child:

1. Which state’s 529 plan should ideally be used when saving for college?
The best part about this plan is that you can invest in any 529 plan offered by any state. You do not need to go for your own state’s plan. It can be used to pay the fees for any college that is qualified nationwide. For instance, you can belong to North Carolina and invest in a California plan. This plan is applicable to over 6,000 colleges across the country and can also be availed for 400 foreign colleges and universities. As long as the institute you choose has the eligibility for 529, you can use your plan to sponsor your education there.

2. What are the tax benefits of this plan?
The federal tax law gives tax benefits with this plan, enabling you to save up for college while also saving up on taxes. If the plan you choose matches specific basic prerequisites, you can avail benefits like the following:

• 5-year gift tax averaging
• Tax-free qualified distributions

3. What is the drawback of opting for this plan?
Something to note about a 529 plan is that it can also be used as an emergency fund. You can use it not only for saving for college but also for saving in general. The funds in this plan belong to you, and you are free to withdraw them anytime you want for any purpose. However, this comes with a drawback. The earnings portion of a non-qualified distribution will be subject to income tax. A 10% tax penalty is levied on this withdrawal, although there may still be exceptions in some cases.

4. Taxable expenses

While non-qualified expenses can be for your own financial needs, there are costs related to education that might not be covered by your plan. For instance, a student’s health insurance, the loan payments by the student, or the transportation costs during college time are not considered to be qualified expenses. In such cases, the withdrawal becomes taxable income.

In a nutshell, investing in a 529 plan is a good idea when you want to start saving for college, but we recommend weighing all your options well before you choose the right plan.