A brief history
529 plans were first authorized by Congress in 1996. Known officially as “qualified tuition programs,” 529 plans are so named because they are governed by section 529 of the Internal Revenue Code.
You can ask for help
With so many plans available, it may be helpful to consult an experienced financial professional who can help you select a plan and pick plan investments. However, there is no guarantee that working with a financial professional will improve your investment results.
Section 529 college savings plans are tax-advantaged college savings vehicles and one of the most popular ways to save for college today.
Much like the way 401(k) plans changed the world of retirement savings a few decades ago, 529 college savings plans have changed the world of college savings.
Tax advantages and more
529 college savings plans offer a unique combination of features that no other college savings vehicle can match:
- Federal tax advantages: Contributions to your account grow tax-deferred and earnings are tax-free if the money is used to pay the beneficiary’s qualified education expenses. (The earnings portion of any withdrawal not used for college expenses is taxed at the recipient’s rate and subject to a 10% penalty.)
- State tax advantages: Many states offer income tax incentives for state residents, such as a tax deduction for contributions or a tax exemption for qualified withdrawals.
- High contribution limits: Many plans let you contribute over $300,000 over the life of the plan.
- Unlimited participation: Anyone can open a 529 college savings plan account, regardless of income level.
- Professional money management: College savings plans are offered by states, but they are managed by designated financial companies who are responsible for managing the plan’s underlying investment portfolios.
- Flexibility: Under federal rules, you are entitled to change the beneficiary of your account to a qualified family member at any time as well as rollover the money in your 529 plan account to a different 529 plan once per year without income tax or penalty implications.
- Wide use of funds: Money in a 529 college savings plan can be used at any college in the United States or abroad that’s accredited by the Department of Education and, depending on the individual plan, for graduate school.
- Accelerated gifting: 529 plans offer an estate planning advantage in the form of accelerated gifting. This can be a favorable way for grandparents to contribute to their grandchildren’s education. Specifically, a lump-sum gift of up to five times the annual gift tax exclusion ($14,000 in 2016) is allowed in a single year, which means that individuals can make a lump-sum gift of up to $70,000 and married couples can gift up to $140,000. No gift tax will be owed, provided the gift is treated as having been made in equal installments over a five-year period and no other gifts are made to that beneficiary during the five years.
Choosing a college savings plan
Although 529 college savings plans are a creature of federal law, their implementation is left to the states. Currently, there are over 50 different college savings plans available because many states offer more than one plan.
You can join any state’s 529 college savings plan, but this variety may create confusion when it comes time to select a plan. Each plan has its own rules and restrictions, which can change at any time. To make the process easier, it helps to consider a few key features:
- Your state’s tax benefits: A majority of states offer some type of income tax break for 529 college savings plan participants, such as a deduction for contributions or tax-free earnings on qualified withdrawals. However, some states limit their tax deduction to contributions made to the in-state 529 plan only. So make sure to find out the exact scope of the tax breaks, if any, your state offers.
- Investment options: 529 plans vary in the investment options they offer. Ideally, you’ll want to find a plan with a wide variety of investment options that range from conservative to more growth-oriented to match your risk tolerance. To take the guesswork out of picking investments appropriate for your child’s age, most plans offer aged-based portfolios that automatically adjust to more conservative holdings as your child approaches college age. (Remember, though, that any investment involves risk, and past performance is no guarantee of how an investment will perform in the future. The investments you choose may lose money or not perform well enough to cover college costs as anticipated.)
- Fees and expenses: Fees and expenses can vary widely among plans, and high fees can take a bigger bite out of your savings. Typical fees include annual maintenance fees, administration and management fees (usually called the “expense ratio”), and underlying fund expenses.
- Reputation of financial institution: Make sure that the financial institution managing the plan is reputable and that you can reach customer service with any questions.
With so many plans available, it may be helpful to consult an experienced financial professional who can help you select a plan and pick your plan investments. In fact, some 529 college savings plans are advisor-sold only, meaning that you’re required to go through a designated financial advisor to open an account. Always carefully read the 529 plan issuer’s official materials before investing.
Once you’ve selected a plan, opening an account is easy. You’ll need to fill out an application, where you’ll name a beneficiary and select one or more of the plan’s investment portfolios to which your contributions will be allocated. Also, you’ll typically be required to make an initial minimum contribution, which must be made in cash or a cash alternative.
Thereafter, most plans will allow you to contribute as often as you like. This gives you the flexibility to tailor the frequency of your contributions to your own needs and budget, as well as to systematically invest your contributions. You’ll also be able to change the beneficiary of your account to a qualified family member with no income tax or penalty implications. Most plans will also allow you to change your investment portfolios (either for your future or current contributions) if you’re unhappy with their investment performance.
529 prepaid tuition plans–a distant cousin
There are actually two types of 529 plans–college savings plans and prepaid tuition plans (prepaid plans are the less popular type). The tax advantages of college savings plans and prepaid tuition plans are the same, but the account features are very different. A prepaid tuition plan lets you prepay tuition at participating colleges at today’s prices for use by the beneficiary in the future. The following chart describes the main differences:
|College Savings Plans||Prepaid Tuition Plans|
|Offered by states||Offered by states and
|You can join any state’s
|State-run plans require you to
be a state resident
|Contributions are invested
in your individual account
in the investment portfolios
you have selected
|Contributions are pooled with
the contributions of others and
invested exclusively by the plan
|Returns are not guaranteed;
your account may gain or lose
value, depending on how the
|Generally a certain rate of
return is guaranteed
|Funds can be used at any
accredited college in the U.S.
|Funds can only be used at
participating colleges, typically
Note: Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans before investing. More information about specific 529 plans is available in each issuer’s official statement, which should be read carefully before investing. Also, before investing, consider whether your state offers a 529 plan that provides residents with favorable state tax benefits. As with other investments, there are generally fees and expenses associated with participation in a 529 savings plan. There is also the risk that the investments may lose money or not perform well enough to cover college costs as anticipated.
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Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.
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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.