How do 529 College Savings Work?

A college savings plan or 529 plan provides a way to save money for college. The saved money, which is after tax money, grows tax free. When you withdraw the savings to use for college expenses, you do not pay any taxes on the growth it has realized over the years.

Let us run a simple comparison of saving $10,000 in a traditional brokerage account versus a college savings plan. Say, we invested this amount 10 years before the kid is ready for college. Further, let us assume that both these accounts were invested in the same assets that produced a return of 10% per year.

Over the 10 year, the $10,000 would grow to $25,937 in both accounts. The capital gains over the 10 years is $25,937 - $10,000 = $15,937. As you can see the total gains is more than the original investment!

When we withdraw the savings from the brokerage account, we will be taxed on the capital gains depending on our tax bracket. For most of us, the capital gains tax rate is 15% which translates to $2391 in taxes. This means we have only $23,547 left for college expenses. However, if we had invested in the college savings plan, you would pay no tax on those gains and save $2,391.

This is the power of saving with a college savings plan.

As you work through setting up the 529 plan for your kids, we are here to help answer any questions you may have.