529 Plans

A 529 savings plan is a tax-advantaged investment plan designed to encourage saving for the future higher education expenses of a designated beneficiary (typically one’s child or grandchild).  The plans are named after the Section 529 of the Internal Revenue Code and are administered by state agencies and organizations.

All withdrawals from 529 plans for qualified education expenses will remain free from federal income tax.  Many states mirror the federal tax advantages for 529 plans by offering state tax-deferred growth and tax-free withdrawals for qualified higher education expenses.

Why State 529 Plans Differ

Each state that offers a 529 plan determines how its plan is structured and which investment options are offered.  While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as a state tax deduction, a matching grant, and scholarship opportunities, protection from creditors and exemption from state financial aid calculations, for investors who invest in 529 plans offered by their state of residence.

Types of 529 Plans

There are two types of 529 plans:  prepaid tuition and savings.  Prepaid tuition plans (sometimes called guaranteed savings plans) are offered in 13 states and allow for the pre-purchase of tuition based on today’s rates and then paid out at the future cost when the beneficiary is in college.  Performance is often based upon tuition inflation.  Prepaid plans may be administered by states or higher education institutions.

Savings plans are different in that your account earnings are based upon the market performance of the underlying investments, which typically consist of mutual funds.  Savings plans may only be administered by states.  48 states and Washington, D.C. offer a savings plan.  Most 529 savings plans offer a variety of age-based investment options where the underlying investments become more conservative as the beneficiary gets closer to college-age.  They also offer risk-based investment options where the underlying investments remain in the same fund or combination of funds regardless of the age of the beneficiary.  In addition, many savings plans offer a stable value or guaranteed option designed to protect an investor’s principal while providing for some investment growth, while others offer investments in certificates of deposit (CDs).

529 Plan Advantages

529 plans are designed to encourage early and consistent savings by offering an easy, affordable and convenient way for families to save for college.  While the tax advantages are one of the primary benefits, states also offer a variety of features and benefits to help families reach their college savings goals.

There are many differences between saving with a tax-free account like a 529 plan versus saving with a taxable account.

• All money grows federal and state income-tax free
• All withdrawals used for qualified higher education expenses are exempt from federal income tax
• Many states also exempt withdrawals from state income-tax for qualified higher education expenses
• The account holder retains control of the assets within the program regardless of beneficiary’s age
• Most plans have a very low minimum monthly contribution limits making them attractive to families regardless of income level.  Some states have minimum limits as low as $15.
• The beneficiary can be changed at any time to another member of the beneficiary’s family
• Money can be used at virtually any accredited college in the country
• Money can be used to pay for tuition, fees, room, board, books, supplies, and required equipment
• Contributions can be made conveniently through payroll deduction or automatic transfers from a bank account
• Many states offer maximum contribution limits of $300,000 or more
• Assets within 529 plans are protected from bankruptcy
• Most states offers a low cost option that can be opened by contacting the plan directly
• Account owners can make a lump sum contribution of up to $65,000 per beneficiary or $130,000 if married filing jointly and avoid incurring a taxable gift on this amount by electing to use five years of the annual gift tax exclusion all in one year.  After utilizing this provision, the annual exclusion cannot be used again for the same beneficiary until the five-year period has passed.  Should a donor die within those five years, a pro-rata amount of the gift will revert back to their estate and be treated as a taxable gift.