What are 529 plans?
Along with buying a house and retirement, college tuition is one of the major expenses that figure large in most families’ budgets. Certainly there’s good reason for this. Tuition rates in the U.S. have been increasing at about twice the rate of inflation, or about 8% per year since 1958. With education costs looming large for many households, many states and educational institutions have begun offering savings plans to help ease the burden. One of the newer offerings is 529 plans, known more formally as “qualified tuition programs”.
This video gives a brief overview of 529 plans:
How do 529 plans work?
Named after the section in the federal tax code that governs them, 529 plans are savings plans that allow you to put money away for education and let it grow tax-free until needed. Distributions from 529 plans are not subject to federal taxes if used for tuition, fees, books, supplies or equipment required for study at any accredited college, university or vocational school in the United States, and at some foreign universities. If the student is enrolled at least half-time, the funds can also be used for room and board. If used for any other purpose, the distributions are taxable as income and also subject to a 10% penalty, unless the beneficiary dies, becomes disabled, or receives another form of educational aid.
Most states offer 529 plans and exempt distributions from state taxes if used for educational expenses. Contributions to a 529 plan are not tax-deductible, and are also subject to the annual and lifetime gift tax limits. Each 529 plan can have only one designated beneficiary, but the funds can be transferred to another beneficiary without penalty. For example, you can change the beneficiary on a 529 plan, or roll over the funds in one beneficiary’s plan to another beneficiary’s 529 plan without tax consequences. Although each state offers its own 529 plan, students are not restricted to attending institutions or using plans only in that state. You can be a resident of one state, enroll in another state’s 529 plan, and attend college in a third state.
You, as the person who purchases the plan, retain control of the plan’s funds. You can decide which state’s plan to enroll in, how much to contribute and when, and when and how to move funds around. You could even take funds out and use them for other purposes (subject to taxes and penalties). Each state’s plan has different policies regarding how funds can be used and distributed. So it’s good to research different plans and see which is best for your situation.
Many states invest the contributions to a 529 plan in a combination of mutual funds. Some states have contracted with professional investment firms to manage their funds, and some allow the plan owner to choose how money in the plan is allocated among different funds.
There are actually two different types of 529 plans. The qualified tuition program is the newer type. There is also an older type, still in existence, called the prepaid tuition program. This allows you to prepay tuition at current rates instead of waiting until later, when tuition rates will be higher. Under this type of plan, the state guarantees that the number of units of education you purchase will be available in the future, regardless of how tuition rates have increased or how the funds in the plan have performed since you purchased it. Most states offer this guarantee at in-state public institutions and some also offer it at private and out-of-state institutions as well.
The rules regarding 529 plans change regularly. For example, the Obama Administration has proposed ending the tax exemption on distributions for new plans. You should consult a financial advisor when setting up a 529 plan.
For more information
To compare different states’ 529 plans, visit www.savingforcollege.com.