Each state has a 529 plan which is considered a state-sponsored investment program. States may give deductions or credits in state income tax for 529 contributions. If you are in a state outside of Texas check the deductions of your state 529 plan on the web.
However, in Texas there is no state income tax so you can consider any state’s 529 plan for the funding of your children’s college expenses. We have come to find that the four best 529 programs for Texas residents are those in Arkansas, Nevada, Utah and Virginia. Arkansas and Virginia require an advisor.
Arkansas: www.iShares529.com (888)529-9552
Nevada: www.upromisecollegefund.com (800)587-7305
Utah: www.uesp.org (800)418-2551
Virginia: www.americanfunds.com/college/college-america/index.htm (800)421-0180.
The contributions made into a 529 Plan are made with after-tax dollars but they benefit from tax deferred growth and tax-free distributions. Each states plan is different and some exceptions apply but generally the additional benefits include, no age limits on when the money must be used and no income limitations on donors.
Anyone can contribute to the accounts and the account owner stays in control of the assets and can withdraw them at any time. However, like ESAs if the withdrawals are not qualified (room, board, tuition or fees for post-secondary studies) there is a 10% penalty imposed on earnings and the earnings portion is also subject to tax as ordinary income at your tax rate. However, some 529 plans allow you to direct your withdrawals to the beneficiary, who most likely is in a lower tax bracket.
You may also have to report additional state “recapture” income on your original contributions. If the beneficiary decides not to go to college, or is unable to spend the amount in the account on qualified expenses one way of avoiding the penalty and tax consequences of emptying the account is to change the beneficiary. You can change the beneficiary to the original beneficiary’s spouse, children, sisters, brothers, nephews, nieces, first cousins, and any spouses of those persons.
Further, an exception the penalty applies in cases in which the beneficiary has died or is disabled, or if you withdraw funds no longer needed for college because the beneficiary has received a scholarship.
You can fund a 529 plan instead of or in addition to an ESA. Both the 529 and the ESA are financial aid friendly because they count as parental assets and therefore add only 5.6% to the expected contribution instead of the much higher cut expected from student assets.