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529 Plans

What is a 529 Plan?

A 529 Savings Plan, also called a Qualified Tuition Program, is a simple and excellent way for students and their families to save for one of life’s biggest expenses: college. This education-designated savings plan’s most significant benefit is that it’s largely tax free. You generally pay no state taxes on the amount you contribute to the account, or any federal or state taxes on the interest the account earns, unless there is extra money leftover that you don’t put towards education expenses.

529 Qualified Expenses

You can use the money you’ve saved in your 529 Plan for any expenses that are required by the school you’re attending. To qualify for some expenses, you must be enrolled at least half-time.

The following expenses qualify:

  1. Tuition and fees
  2. Books, supplies, and equipment (Not only your textbooks, but also any equipment you need to complete your education, such as tools for a machining degree, qualify)
  3. Computer technology, equipment, and Internet access (So a laptop or desktop computer and any needed software are eligible expenses)
  4. Room and board (this expenditure only qualifies if you’re enrolled at least half-time)
  5. Expenses for special needs services

529 Savings Plan Benefits

Aside from being tax free, 529 Plans have a host of other benefits to students and parents:

  1. Account Control - The investor (frequently the parents as opposed to the student) has control of the account. Unlike with custodial accounts or Educational Savings Accounts (ESAs), which transfer control to the designee at ages 18 or 21, the investor retains permanent control of a 529 Plan. So parents can rest assured their hard earned savings will go towards college and not backpacking through Europe.
  2. Anyone Can Contribute - Anyone can contribute to the 529 Plan. So if grandma and grandpa want to give a monetary birthday gift intended to be saved for college, they can deposit it directly into the plan.
  3. No Restrictions on Who Can Open an Account - You can open an account for anyone; a child, grandchild, a friend’s child, or for yourself.
  4. In the Case of Scholarships or Non-Attendance of College - If the child the account was intended for decides not to go to college, the account can be re-designated to another family member. Other family members are defined as "the original beneficiary’s spouse, children, sisters, brothers, nephews, nieces, first cousins, and any spouse of those persons." If the original beneficiary gets a scholarship, the 529 Plan can be rolled over to any of the previously listed relatives with no penalty, or you can withdraw the remaining funds without any penalties, but you do still have to pay taxes on them.
  5. Generally No Age or Time Limits - You can use the money to attend school at any age in most states.
  6. Income Eligibility – You can enroll in a 529 Plan regardless of your income. You can’t open other college savings accounts like an ESA if your yearly household income is above $220,000; $110,00 per individual.

529 Contribution Limits

First of all, you should be aware that 529 contribution limits apply to the beneficiary the money is being saved for, as opposed to the individual plan. One student can have invested money in several different plans, but the limitations apply to the total amount of money invested in 520 Plans for that student, not each individual savings plan.

Secondly, the total contribution limit is usually quite high: the amount that will be needed to cover tuition and all other qualified educational expenses.

However, yearly contributions are restricted a bit more; contributions made to a beneficiary of over $13,000 in one year can be subject to gift taxes.

Individual states also have their own contribution limits, so check the rules in your state before investing.

Prepaid Tuition Plans

There are 2 different types of 529 Plans, named for its section number in the IRS code, a Prepaid 529 Plan and a Savings 529 Plan.

Prepaid Plans allow an investor (generally a student’s parents) to purchase credits at participating educational institutions for future tuition and fees (and sometimes room and board), so that tuition prices are locked in. You can pay for a future student’s tuition at today’s prices to avoid the steady tuition hikes most universities are imposing. However other expenses, such as books, supplies, equipment, and computers, are not covered by this plan. Room and board are also frequently not covered. However, many Prepaid Plans are federally insured and guaranteed by state governments.

College Savings Plans

In Savings Plans, all growth is based on the market performance of the underlying investments. The investor can choose a particular investment option, such as stock mutual funds, bond mutual funds, or money market funds, in which to make his or her contributions. You can also elect to work with an advisor, who will help you select investments based on your investing strategy and how much risk you want to take. Savings plans can be used for all educational related expenses outlined in the previous section, including books, supplies, equipment, and computers. However, if you choose to invest it mutual funds, your savings plan will not be federally insured or guaranteed by the state.

529 Plan Comparison

The following chart outlines the major differences between Prepaid and Savings 529 Plans:

Prepaid Tuition Plan College Savings Plan
Tuition Lock Locks in tuition costs at today’s prices. No lock on tuition costs.
Qualified Expenses Only covers tuition and fees.

Room and board are qualified expenses on some plans, and some plans will allow you to use leftover tuition credits for other college-related expenses.
All qualified higher education expenses are covered:
  • Tuition and fees
  • Books, supplies, and equipment
  • Computer technology, equipment, and internet access
  • Room and board
  • Special needs services
Enrollment Period Limited enrollment period for most plans. You can enroll at any time throughout the year.
State Guarantee Most plans are guaranteed or backed up by the state. Not guaranteed by the state. The market will affect your investment so you may make no profit or even lose money.
Age Limit Most plans have an age or grade limit for the designated beneficiary. No age limits.
Residency Requirements Most plans require state residency of either the investor or the beneficiary. No residency requirements. You can purchase a plan in any state.

529 Plan Tax Benefits

There are two tax breaks in the 529 Plan, one deducted immediately and one differed.

Your immediate deduction is in the form of a state income tax deduction. Unless the plan’s account owner or its beneficiary live in one of the seven income-tax free states, contributions to the plan are deductible to the state’s limit. However, deduction limitations vary wildly from state to state. While some states allow a deduction of all 529 contributions, others will tax the entire contribution as regular income. If your state does offer deductions, they will apply to your contributions every year.

Your differed deduction happens when the time comes to use your 529 savings for education; then your expenses are fully deductible from your federal taxes, and in most states, from state tax as well. That includes any interest or monetary gains the fund has earned over the years.

529 Plan Administration

529 Plans are first administered by the state that offers them. States then can either fully perform the administrative duties of that plan or, more often, states may use an independent financial services company to manage some or all of those duties.

Choosing Your 529 Plan

Well over a hundred 529 Plans are available to every family in the United States. While all of these plans operate under the same tax provisions previously discussed, no two are identical. Sorting through all the different plan options can be difficult and confusing, however the variety of options allows you to find a plan focused on your individual needs and expectations.

You can find 529 plans in your state on the College Savings Plans Network website.

529 Savings Plans since the Recession

While crucial for most Americans, financial planning is extremely complicated. With so much misinformation and biased sources, many Americans slam the breaks on their investments and just pull away from all the confusion. In 2008 and 2009, 529 investing took a major dive as investors feared the recession would wash away all of their hard earned savings. While it is a certainty that some investments were hurt by the recession, 529 plans are only as risky as you choose to make them. You have the ability to choose incredibly safe and stable investments, or take greater risks. Many 529 Plans have performed admirably well for the past 5 and 10 years and investors should take the time to evaluate their desired amount of risk before they entrust vital savings to a financial service.