529 College Savings Plan Overview

October 3, 2009

A 529 college savings plan is another way for U.S. families to prepare for the high costs of college. Named after section 529 of the Internal Revenue Code, this investment vehicle has some similarities with and differences from the Coverdell ESA.

A 529 plan is another tax-advantaged plan that is designed to give incentives for education planning. Like the ESA, there is one custodian and one beneficiary for each account. The beneficiary can be anybody, even yourself (yes, you can go back to school for that degree you’ve been thinking of AND take advantage of the 529 for yourself).

State 529 Plans

Each state manages their own 529 plan and usually offers incentives for its residents to utilize the in-state version. Some states offer state tax deductions for contributions to residents. If you feel the tax deduction is not as important as performance, you can do the research and pick a better program and invest in that plan.

There are two types of 529 plans: the prepaid tuition program and the savings program.

529 Prepaid Tuition

The pre-paid plan gives you the ability to purchase future tuition at today’s prices. It generally covers all state and community colleges and may encompass private schools as well. It is best to confirm if your state offers this program and what the rules and limitations are. In this program, all funds are pooled together and invested to cover the increase in tuition over time (or so they hope).

Many of these pre-paid plans require that the beneficiary be 15 years old or younger. The tuition can be purchased in a lump sum or paid through monthly installments. Be aware, having a pre-paid tuition plan does NOT guarantee that the student will be accepted to that school.

529 Savings Program

The savings plan works much like a 401k does, in that the custodian has the choice of choosing the different mutual funds offered in the plan to invest in. In most cases, the “age-based” portfolios are the most popular. There are generally some kind of maintenance fee associated with the plan, and if the plan is bought through a financial advisor, mutual fund-type commissions. Each state offers different options and must be researched before you make a decision.

529 Contributions

Currently the contribution limits follow the rules for gifting. $13,000 may be contributed per beneficiary per person. This means mom & dad can put $13,000 each in for little Johnny or Suzy. There is a 5-year “pay-forward” in which you can put up to five years worth in at one time. This works out well for estate purposes; Grandma & Grandpa can each contribute $65,000 and remove the funds from their estate for tax purposes.

There are no income or age limitations to the savings plan. Anybody can contribute and take advantage of the opportunity. Like ESAs, 529 plans are also not factored in when applying for financial aid.

529 Distributions

Like the ESA, qualified withdrawals are federally tax-exempt, and in most cases, state as well. Unlike the ESA, 529s can only be used for secondary education. These funds can be used at any accredited college or university in the US, and in some cases, abroad as well.

If the beneficiary does not go to college or receives a scholarship, there are options to do something with the funds. One alternative is that they can be transferred to another member of the beneficiary’s family. If the funds are withdrawn for an unqualified reason, the earnings (but not the original contribution) would be subject to both federal and state taxation as well as a 10% penalty.

College Savings Plan

It is estimated that for children born this year, the average cost of a four year college education will cost over $250,000. Sure, that number is intimidating but it will be less so if you start saving now, even if it’s only one dollar at a time.


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