A Great Way to Save for College
529 plans have become one of the more popular options for families saving for a child's college education, and for good reason. Though the plans differ from state to state, they are all exempt from federal income tax, and that can give a real bottom-line boost to your college fund.
What Is a 529 Plan?
A 529 plan is a state-operated investment plan that gives families a federal tax-free way to save money for college. Authorized by Congress in 1996, they are officially known as qualified tuition programs (QTPs), but commonly referred to as "529 plans," "state 529 plans," or "section 529 plans" after the section of the IRS code that provides the plans' special tax breaks.
Two Types of 529 Plans
529 plans come in two varieties—college savings plans and prepaid tuition plans. Nearly every state has at least one of these two options and many states offer both. College savings plans let parents use their plan funds for college expenses at any college. Prepaid tuition plans let parents lock-in future tuition at in-state public colleges at present prices. Get the facts about each plan, and decide which type might be right for you:
Learn More:
College Savings Plans
Prepaid Tuition Plans
529 Plan Facts
- Earnings from a 529 plan are exempt from federal taxes, as are any withdrawals, as long as they go toward paying college costs.
- Some states waive state taxes for residents, other states allow deductions on contributions.
- The 529 plans have generous maximum contribution limits—some as high as $250,000 per beneficiary.
- Most states hire experienced investment companies, such as TIAA-CREF, to manage their 529 accounts.
- If funds are withdrawn for purposes other than education, the earnings are subject to a 10 percent penalty as well as federal income tax. States may assess their own penalties.
- Great for grandparents: 529 contributions are considered completed gifts and are excluded from your estate. Grandparents can also switch beneficiaries to other grandchildren.
Note: Each 529 plan has its own set of rules and restrictions, which are subject to change. Make sure to request the most recent plan details from plan administrators.
Now Is the Best Time to Start a 529 Plan
The Economic Growth and Tax Relief Act of 2001 makes 529 plans even more appealing, beginning in January 2002.
- Withdraw funds for educational expenses, federal tax-free.*
- Switch investment options within the same plan, once per year.
- Roll over one 529 plan into another, once per year.
- Contribute to Coverdell Education Savings Accounts (formerly Education IRAs) and 529 plans in the same year.
- Switch beneficiaries to first cousins.
Which Plan is Right for You?
A college savings plan may offer you more options than a prepaid tuition plan. The savings method gives you much greater flexibility in college choice, an important advantage considering that a savings plan can begin 10-15 years or more before the college selection process gets underway. (If you like the idea of prepaid tuition, you can do this through a college savings plan by using four years of in-state public tuition as your savings goal). Another advantage of college savings is that, if your child qualifies for need-based aid, the federal formula will ask you to contribute less from college savings than from a prepaid tuition plan.
529 Tips
- Do your homework. Like any other investment, it's up to you to make sure you know exactly what you're getting into.
- Contact your state's treasury or finance office (or whichever office is responsible for college savings plans) for information on your state's offerings.
- Talk to a financial advisor and/or tax adviser before making any decisions that have tax or estate implications.
- Make sure you're aware of all fees and penalties. Each plan will have its own rules about early withdrawals, refunds, transfers, or using the money for purposes other than education.
More Information on 529 Plans
Collegesavings.org is the information clearinghouse of current 529 plans for the College Savings Plans Network, an affiliate of the National Association of State Treasurers.
Savingforcollege.com is devoted to 529 plans and includes articles, FAQS, and ratings of each state plan. It was founded by accountant and 529 specialist Joseph Hurley.