So you’ve probably heard of the 529 College Savings Plan, but what exactly is it and how does it work?
That’s what we want to answer today. Surprisingly, 529 College Savings Plans have been available since 1996 with the Small Business Job Protection Act.
The 529 plans were then refined in 1997, 2001 and again in 2006 with the Pension Protection Act. 529 College Savings Plans have really become one of, if not the most popular way to save for college!
529 College Savings Plans got their name from Section 529 of the IRS code that allows for the special tax provisions related to these savings plans, which we’ll address.
What Exactly is a 529 College Savings Plan?
A 529 College Savings Plan is simply an account that allows you to save for college and has federal and (depending on the state) state tax advantages with regards to contributions and withdrawals for college.
Each state has its own 529 plan and has selected a company to administer their plans for them. For example, I live in Indiana where we have the Indiana College Choice 529 Plan through UPromise Investments.
There are actually two types of 529 plans - a college savings plans and a prepaid tuition plan. They share the same tax advantages, but there are some differences that we’ll reserve for a later post.
Today we’ll focus on the college savings plan portion.
How Does a 529 College Savings Plan Work?
A 529 College Savings Plan is simply an individual account that you save into where you pick a model or a target portfolio to invest into based on your age and risk tolerance.
Many plans have an “age-based” portfolio where the allocations are more aggressive in the child’s earlier years and as they get older the allocations switch to a more conservative mix.
There are also static portfolios where you can pick an allocation that doesn’t change over time.
These accounts are set up in the parents name with the child listed as beneficiary, so the parent retains the ownership and decision-making powers on the account.
When it’s time for college, the beneficiary can use the funds at any college in this country and abroad – as long as the school is accredited by the U.S. Department of Education.
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Advantages of a 529 College Savings Plan
529 College Savings Plans offer some pretty attractive advantages for those seeking to save for college – here’s a few:
- Tax-deferred growth - The money you contribute to a 529 plan grows tax deferred each year.
- Federal tax-free withdrawals – If the money is used for college, your withdrawals of contributions and earnings are not subject to federal income tax!
- State tax advantages – States may provide their own tax advantages to 529 plans. For example, Indiana allows for a 20% state tax credit up to $1,000 on contributions! Check your states rules on 529 College Savings Plans.
- Anyone can open and contribute - You don’t have to be a parent to open and contribute, which makes these plans very attractive for grandparents!
- High contribution limits - A lot of plans allow for very high contribution limits, sometimes upwards of $300,000 or more! In contrast, Coverdell Education IRAs allow for only $2,000 per year.
- Flexibility - You are not limited to choosing your own states plan, although you may not receive your state’s tax benefits.
- Simple and easy – You don’t have to worry about the investments too much since you choose model portfolios and 529 College Savings Plans are very easy to open – you can do it right online!
- You can switch beneficiaries – In other words, let’s say your oldest daughter decides she doesn’t want to go to college, you can remove her as beneficiary and add your son as beneficiary.
Disadvantages of a 529 College Savings Plan
Of course there is no such thing as a perfect savings plan, so here are some of the disadvantages:
- Investment options - You can pick portfolios, but not the underlying investment options.
- Investment inflexibility - Your plan may only allow you to change investment portfolios at certain times throughout the year.
- Consequences of not using money for college- Known as “nonqualified withdrawals”. You’ll have to pay a 10 percent federal penalty on the earnings part of any withdrawal that is not used for college expenses – depending on the state, there may be penalties from them as well. You will also pay income taxes on the earnings too!!
- Fees and expenses – Of course there are fees associated with 529 College Savings Plans. You may have annual maintenance fees, mutual fund expenses and the like.
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{ 7 comments… read them below or add one }
Question…
Can you “rollover” a 529 plan? For example, if you have a child that decides not to go to college and pursue a different career path, or attend a school not accredited by the US Dept. of Education…
But then you have a 2nd younger child that is potentially college bound. Can you roll the 529 plan into an existing 529 plan for the 2nd child? What about transfer names if a 2nd plan doesn’t exist.
I really wish my parents put at least some money into a 529 for me.
Parents, please do put some money into a 529 or dedicated plan so that your child does not have to suffer through the payments of college loans. We greatly appreciate it!
.-= Zach @College for 10k´s last blog ..Inboxdollars: Is it legit? =-.
Kita, great question! In your example you would simply change beneficiaries on the account. You don’t have to “roll over” the funds, just change who the beneficiary is.
Zach, thanks for checkin’ in and I appreciate your plea to parents. Even a little into a 529 saved for several years could greatly help with books etc.
My daughter-in-law started a 529 for my grandson soon after he was born. Part of the gifts to him for Christmas birthdays will be donations to his account.
By the time he’s ready for college it should be a nice amount as long as his parents keep donating.
.-= Bucksome Boomer´s last blog ..Reducing Health Care Costs =-.
Bucksome – that’s great to hear that your daughter-in-law started early!! What’s great about the 529 is the flexibility of it and the fact that so many others can contribute to it etc.
This is a savings plan sponsored by state to encourage people to save for college expenses. Parents can contribute towards this plan to pay some, if not not all, college expenses of their children. However, it’s not mandatory to use the funds for your child. You can, at any time, change the beneficiary of the plan. Along with compulsory savings, this plan offers certain tax benefits.
529 College Savings Plan or 529 prepaid Plan
529 plans can be broadly classified into two categories: 529 College Savings Plan and 529 Prepaid Plan. The regulations regarding deposits and withdrawals in such plans can vary from state to state. However, in general, savings plan are more flexible than prepaid plans, regardless of the state you live in.
A 529 College Savings Plan allows you to use funds for any kind of college expenses, at any university, and in any state. A prepaid plan, however, prohibits usage of this money in any state other than your home state.
http://www.financegenie.net/529-college-savings-plan.html
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