529 College Savings Plan
With tuition costs rising every year, saving for college is a top priority for most families with children. A 529 savings plan, also called a qualified tuition program, allows you to build up savings to pay for qualified higher education at eligible institutions using tax-free dollars. 529 plans were named after a section of the tax code and are offered through states.
How It Works
The 529 savings plans let parents save for qualified college costs free of federal and sometimes state taxes. Qualified costs include room and board, tuition and books. Prepayment may be in the form of a contribution to an account established specifically for paying higher educational expenses.
There is no income restriction for individuals who want to contribute to a 529 plan. Some states do have a maximum total dollar amount that can be contributed over the lifetime. Be aware that any contributions made that exceed any qualified costs will be taxed as ordinary income upon withdrawal and are subject to a penalty. In this case, over saving may hurt in the form of taxes and penalties.
All 50 states offer at least one type of 529 savings plan. State plans are typically managed by mutual fund companies. You aren’t limited to your home state’s plan, although you might give up state level tax breaks if you choose an out-of-state plan.
The amount of federal aid a student is eligible to receive is affected by any 529 plan. The value of a 529 account is reported on the federal financial aid applicationas a parental asset.
There are three types of 529 plans: traditional savings plans, prepaid tuition plans, and independent plans.
Traditional Savings Plans
Traditional 529 savings plans are the most common 529 option. They invest in a basket of mutual funds and the earnings grow tax-free.
Typically you can decide between direct investments in the plan, where you purchase shares directly from the plan manager, or you can opt for a broker-sold plan. If you want more guidance and direction, a broker-sold plan might be for you, but be aware of fees charged by brokerage firms.
Opening a traditional 529 account is not expensive and some states allow you to enroll for as little at $15. Each state plan will have its own minimum initial contributions as well as minimum levels for additional contributions. Most will offer an automatic enrollment plan that allows for monthly contributions. Be sure to find out about all additional fees such as enrollment or application fees, account maintenance fees and management fees. Savingforcollege.com (www.savingforcollege.com) has a 529 search tool that allows you to search for plans based on a number of criteria and compare multiple plans.
In most cases a traditional 529 savings plan can be used nationwide, meaning you do not need to invest in the state where you will be paying tuition.
You will have a number of options when choosing the investment vehicle for your 529 savings plan. Each state has different offerings but they will typically consist of age-based funds (contributions are put in funds based on a specified risk level and the number of years until expected enrollment), target allocation funds (funds have varying risk tolerance) and traditional mutual funds.
Prepaid tuition plans lock in future college costs at today’s prices. When you invest in a prepaid plan, you usually buy a piece of in-state tuition. Each state has its own plans and residency requirement. In most cases, these plans can be converted for use at private and out-of-state colleges as well.
Prepaid plans are guaranteed to increase in value at the same rate as tuition inflation. Tuition and fees at public four-year colleges and universities have risen at an average of 7% according to the College Board. For example, if you put $1,000 in a prepaid plan today for a newborn, the money would cover $3,380 worth of college costs in 18 years (assuming a 7% per year rate increase).
Not all states offer the prepaid plans and some are restricted to in-state investors only. Typically these plans cover only tuition and mandatory fees, meaning housing may not be covered.
Independent 529 Plans
Independent 529 plans are private-college-run plans. It is a pre-payment type of plan that allows you to lock-in tuition at any of 270-plus member schools. All member colleges offer a discount of at least 0.50% per year off their current tuition, which means that you pay less than today’s price for tomorrow’s tuition.
Payments received by the program are pooled into a trust fund managed by TIAA-CREF. All colleges included must agree to accept the tuition certificates from all participants.
Like the state-run 529 plans, independent 529s are allowed to grow free of federal taxes. Some states offer tax incentives for these plans as well. There are no start-up or maintenance fees.
How to Purchase
You can purchase a 529 plan through a broker or directly from the plan administrator. Most plans have a dedicated Web site with contact and enrollment information. Most plans can be purchased on-line and allow you to make automatic monthly payments as well. Each state’s Web site should have links to the various plan offerings.
529 savings plans are useful for anyone with children (or grandchildren) who plan to attend college. The tax incentives make these plans especially enticing.
Money in a 529 plan grows free of federal taxes, and some states extend their own tax breaks. Withdrawals from 529 plans are also exempt from federal and sometimes state taxes, as long as the money goes to qualified educational expenses, such as tuition and room and board. Non-qualified 529 withdrawals are taxed as ordinary income and are subject to a penalty.
Setting up automatic contributions to a 529 plan makes saving for college easy and allows parents to save specifically for college, as using the money for non-college purposes means paying taxes and penalties.
You money grows tax free as long as it is used for tuition and related higher education expenses.
Minimal Investments and Low Fees
Most state-sponsored 529 plans have low investment minimums and low fees. The independent 529 plans have no minimum initial investment fee and no annual maintenance fee.
Lock in Tuition Rates
If you choose a pre-payment or the independent 529 plan you are locking in today’s tuition prices for the future.
Most state plans offer a number of choices of funds to invest in. You can pick from individual funds or baskets of funds that have been bundled with a specific allocation or risk tolerance in mind.
If you save more than the cost of tuition, room and board and other qualified expenses, you will be taxed and incur an additional penalty fee when withdrawing the remaining money from your account.
Traditional 529 plans invest in mutual funds, meaning if the fund’s value declines so does your investment.
This free Web site offers educational information about saving and paying for college. There is a wealth of data on 529 plans including articles, FAQs and a search and comparison tool. In addition, the site discusses applying for student loans, scholarships and grants.
Independent 529 Plan
The Independent 529 Plan Web site is free and offers a great deal of information. You can view a list of participating schools, learn about how the plans work, see a list of fees and minimum contribution requirements, and read answers to frequently asked questions. You can also use the site to register for a 529 plan, make contributions and access your account information.