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While saving for higher education is its own reward, saving on your taxes while saving for higher education is a bonus you don’t want to pass up.

Many investors save for college using a combination of investment accounts—including 529 college savings plans, bank savings accounts, CDs, and taxable mutual funds. In fact, industry research shows that half of the investors who have a 529 plan use it to hold only a relatively small portion (40% or less) of their total college savings.1

To maximize the tax perks while saving for college, consider consolidating your college funds in a 529 plan.

“It’s important to think about how much you’re saving for higher education,” said Char Gross, who leads Vanguard Education Savings Group. “But it’s also important to think about where you’re investing your savings. If you’re going to set aside money for college, maximize the value of each dollar you contribute by taking advantage of the tax perks of a 529.”

Tax savings times three

You can’t measure the value of helping a loved one pursue academic dreams. But you can measure the value of the tax savings.

Investing in a 529 offers the following tax benefits:

  • Tax-free withdrawals. You can withdraw the money tax-free (both federal and state) when you use it for qualified higher-education expenses.
  • Tax deductions. You may deduct contributions on your state tax return, depending on your state’s rules.2 Learn more about tax deductions.
  • Tax-deferred growth. Your earnings will be deferred from federal (and usually state) taxes.3

Additionally, you can contribute a single lump sum (up to $70,000 per beneficiary or $140,000 if married filing jointly) and count the contribution, for tax purposes, as if you made it over a five-year period.4

Pay less, save more

“Let’s say you invest $10,000 for your child’s education, and the account grows to $15,000 by the time you withdraw the money to pay for college,” said Ms. Gross. “If you had saved the money in taxable mutual funds, and your tax rate on investment earnings was 20%, you’d pay $1,000 in taxes. But if you saved that money in a 529 plan, you’d pay $0in taxes.”

1 Source: Strategic Insight 529 Industry Analysis 2015.

2 The availability of tax or other benefits may be contingent on meeting other requirements.

3 Earnings on nonqualified withdrawals may be subject to federal income tax and a 10% federal penalty tax, as well as state and local income taxes.

4 Any additional gifts made to the beneficiary during that five-year period will incur a gift tax. In the event the donor doesn’t survive the five-year period, a prorated amount will revert back to the donor’s taxable estate.

Note:

  • Investment returns are not guaranteed, and you could lose money by investing in a 529 plan.