What is a 529 Plan?

All the information you need to know about this tax-advantaged college savings option.

WHAT IT IS:

A 529 plan is a college savings plan that is sponsored by a state agency or the state itself. Savings can be used for a variety of expenses including tuition, books, and other education-related expenses. There are two types of 529 plans: prepaid tuition plans and college savings investment plans.

SAVINGS VS PREPAID:

Savings plans are similar to 401K or IRA in that your contributions are invested in mutual funds or similar investments. Depending on what type of savings plan you choose, it will go up or down in value based on how it performs.

Prepaid plans allow you to pre-pay all or part of the costs on an in-state public college or university education. There are also separate plans that can be converted to use for private or out-of-state colleges and universities.

WHO IS ELIGIBLE TO INVEST?

There are no income restrictions when it comes to opening a 529 plan. Any U.S. resident who is 18 years or older and has a U.S. mailing address, along with a Social Security number or Tax ID can apply for a 529 plan.

Many people would like to contribute to a person’s child college savings plan. Along with the owner of the account, parents and grandparents may wish to contribute as well. The owner or participant of the account controls it, including investment decisions and asset distribution. Both relatives and non-relatives can gift money to an already existing account. Some plans even provide an easily accessible page for family and friends to contribute money electronically.

HOW DOES IT WORK:

After deciding what type of 529 is best, enrolling can take place through 529 Plan managers or financial advisors. Choosing a plan that is sold through an advisor, rather than the state, will create additional advisor fees that could increase the overall plan cost.

The owner can make a withdrawal from their 529 account at any time. If the money is not spent on higher education expenses, a minimum of a 10% federal penalty tax and state or local taxes are also added. An example in which this does not apply is if the owner receives a scholarship or attends a U.S. military academy.

As stated before, college savings plans can be applied to eligible institutions including accredited colleges, graduate schools, along with professional and trade schools. Contributions can be applied to tuition, books, and room and board depending on the amount of time attended. Books are an example of  an “approved transaction”. Contributions that are spent on unauthorized purchases may create additional penalties and vary from plan to plan.

BENEFITS OF 529 PLANS:

1. Tax Benefits: Contributions are not deductible, but earnings can grow federal tax-free and will not be taxed when money is taken out. The owner can also claim state tax benefits every time they contribute to their plan. Even if their own state doesn’t offer benefits for residents, it’s possible to choose another state’s plan. Tax reporting is also simple because the plan does not have to be reported on federal tax returns.
2. Low Maintenance: 529 plans are simple to enroll in by visiting the website plan or contacting a financial advisor. Most plans allow automatic investments and direct deposit options that can link to bank accounts.
3. Flexibility: Anyone can change their 529 plan investment options twice a year and funds can rollover into other 529 plans. There is no limit on the frequency of the changes including replacing beneficiaries.
4. Eligibility: Everyone can take advantage of a 529 plan529 plans have no income limits or annual contribution limits, although there are lifetime limits that vary from plan to plan.

WHAT TO CONSIDER AS YOU CHOOSE A PLAN:

Every 529 plan carries its own set of fees. These fees include, but are not limited to, advisor fees, program management fees, maintenance charges, and underlying investment fees.When choosing a plan, be sure to look into the various fees that may arise, as well as if any waivers apply.

Each state enforces its own set of regulations for 529 plans. One person can own a 529 account, but that person can own multiple accounts. There are limits to contributions. Owners and beneficiaries can receive contributions from more than one account as long as the total sum does not exceed the maximum contribution limit.

Keeping in mind that each state has its own set of rules and regulations regarding 529 plans, it’s important to consider an in-state plan or a plan from another state. The most popular option is choosing an in-state plan because owners can claim the tax deduction. If the residential state has no income tax, the decision comes down to fees and living expenses.