A Great Way to Save for College
529 plans have become one of the more popular options for families saving for a
child's college education, and for good reason. Though the plans differ from state
to state, they are all exempt from federal income tax, and that can give a real
bottom-line boost to your college fund.
What Is a 529 Plan?
A 529 plan is a state-operated investment plan that gives families a federal
tax-free way to save money for college. Authorized by Congress in 1996, they are
officially known as qualified tuition programs (QTPs), but commonly referred to
as "529 plans," "state 529 plans," or "section 529 plans" after the section of the
IRS code that provides the plans' special tax breaks.
Two Types of 529 Plans
529 plans come in two varieties -- college savings plans and
prepaid tuition plans. Every state has at least one of these two options
and many states offer both. College savings plans let parents use their plan funds
for college expenses at any college. Prepaid tuition plans let parents lock-in future
tuition at in-state public colleges at present prices. Get the facts about each
plan, and decide which type might be right for you:
529 Plan Facts
- Earnings from a 529 plan are exempt from federal taxes, as are any withdrawals,
as long as they go toward paying college costs.
- Some states waive state taxes for residents, other states allow deductions on contributions.
- 529 plans have generous maximum contribution limits -- some as high as $250,000
- Most states hire experienced investment companies, such as TIAA-CREF to manage their
- If funds are withdrawn for purposes other than education, the earnings are subject
to a 10 percent penalty as well as federal income tax. States may assess their own
- Great for grandparents: 529 contributions are considered completed gifts and are
excluded from your estate. Grandparents can also switch beneficiaries to other grandchildren.
Note: Each 529 plan has its own set of rules and restrictions, which are subject
to change. Make sure to request the most recent plan details from plan administrators.
Now Is the Best Time to Start a 529 Plan
The Economic Growth and Tax Relief Act of 2001 makes 529 plans even more appealing,
beginning in January 2002.
- Withdraw for educational expenses federal tax-free.*
- Switch investment options within the same plan once per year.
- Roll over one 529 plan into another once per year.
- Contribute to Coverdell Education Savings Accounts (formerly Education IRAs) and
529 plans in the same year.
- Switch beneficiaries to first cousins.
- Federal tax exemptions on distributions will "sunset" after Dec. 31, 2010, unless
Congress acts to extend them.
For more information consult IRS Publication
Which Plan is Right for You?
A college savings plan may offer you more options than a prepaid tuition plan.
The savings method gives you much greater flexibility in college choice, an important
advantage considering that a savings plan can begin 10-15 years or more before the
college selection process gets underway. (If you like the idea of prepaid tuition,
you can do this through a college savings plan by using four years of in-state public
tuition as your savings goal).
Another advantage of college savings is that, if your child qualifies for need-based
aid, the federal formula will ask you to contribute less from college savings than
from a prepaid tuition plan.
- Do your homework. Like any other investment, it's up to you to make sure you know
exactly what you're getting into.
- Contact your state's treasury or finance office (or whichever office is responsible
for college savings plans) for information on your state's offerings.
- Talk to a financial adviser and/or tax adviser before making any decisions that
have tax or estate implications.
- Make sure you're aware of all fees and penalties. Each plan will have its own rules
about early withdrawals, refunds, transfers, or using the money for purposes other
More Information on 529 Plans
The Web site of the College Savings Plans Network, an affiliate of the National
Association of State Treasurers. Includes an information clearinghouse of current
Comprehensive site devoted to 529 plans, founded by accountant and 529 specialist
Joseph Hurley. Includes articles, FAQS, and ratings of each state plan.