For those following current events in the community, there was a recent “event” concerning 529 accounts. I suspect, however, that some of you are still a bit confused. Let’s explain it, starting from the beginning.
Once upon a time, college was not expensive. Colleges kept their costs down. Their buildings were old (so old that they had ivy growing all over them – hence, the term Ivy League), and I guess the professors did not earn that much. Over the years, the price tag has risen considerably. Colleges discovered that they are big business.
The government heard about the problem with rising college tuition, and they came up with a solution: Save! Yep – start saving money when junior is a baby, and then you will have money when he’s ready to depart for the dorm. (See Genesis 41 regarding similar advice given to Pharaoh.) That seems simple enough. People would just put money in the bank or a stock brokerage and save up. But the government felt that people needed an incentive to save. So, true to form, they used income taxes to create the incentive. They passed a law that goes like this: If you save for college, all the earnings in that account are tax free. Let’s explain: Say you save $2,000 a year for 10 years. You have therefore put in $20,000. Typically, this money is invested in mutual funds that invest in the stock market, which may pay dividends and also go up in value. The account might therefore have grown and now has $30,000 in it. This money can now be used for college. However, if you withdraw the money and do not use it for college, the earnings of $10,000 are taxable (although the original $20,000 remains “your money”).