If you’re saving for college, consider a Section 529 plan. Although contributions aren’t deductible for federal purposes, plan assets can grow tax-deferred. (Some states do offer tax incentives for contributing.)
Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, equipment, supplies and, generally, room and board) are income-tax-free for federal purposes and typically for state purposes as well, thus making the tax deferral a permanent savings.
529 plans offer other benefits as well:
- They usually offer high contribution limits, and there are no income limits for contributing.
- There’s generally no beneficiary age limit for contributions or distributions.
- You can control the account, even after the child is of legal age.
- You can make tax-free rollovers to another qualifying family member.
Finally, 529 plans provide estate planning benefits: A special break for 529 plans allows you to front-load five years’ worth of annual gift tax exclusions and make up to a $70,000 contribution (or $140,000 if you split the gift with your spouse).
The biggest downside may be that your investment options — and when you can change them — are limited.