529 Accounts

Overview: 529 savings account (529 plan)

A 529 plan is a plan to save money for college costs set up pursuant to Section 529 of the Internal Revenue Code. Operated by a state or an educational institution, it is designed to reduce taxes while you are putting money away for education.

There are basically two kinds of 529 plans: prepaid and savings. Prepaid plans cover tuition at in-state colleges and universities. Savings plans can pay for more stuff, such as books and room and board.

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Prepaid 529 plans are generally set up at a fixed cost, which can be paid in a lump sum or over time. They pay tuition at in-state schools, so they are a hedge against tuition increases. The plans can range from one year at a community college to five years at a university, or a variety of combinations. The cost is based on the age of the child and the plan to be used.

These plans may cover your own state schools, but what if Junior doesn't want to go to State Tech? If your child goes to a private school, or one out of state, the value of the contract can be applied to that school. It may not cover all of the tuition, but it will help.

Savings plans are just that - savings. They do not guarantee tuition costs but can be used for a wider variety of expenses than prepaid plans. The cost can be whatever you want to put in, since there is not a specific plan cost.

Risks involved include a penalty attached to early withdrawals. With savings plans, there is a chance that it will lose money (it's an investment!), and there's a better chance of lower returns in a bad year. Another risk is that there may be higher yields to be earned elsewhere, although this is not a risk for most who are not investment-savvy.

Advantages? There are several, which can be called tax, control, hands-off and limits. In more detail, these are:

  1. There is no federal tax on distributions made for college costs, so the income is (federal) tax free. Some states offer tax breaks as well, such as no tax on distributions or a deduction for the investment into a plan.
  2. The person who sets up the account keeps control because the beneficiary does not own it. That means that if you set it up, you can withdraw it for yourself if need be (subject to penalties), or you can change the beneficiary if Junior no longer needs the funds.
  3. It is an easy way to invest for college in that you can sign up for automatic deposits or payroll deductions.
  4. There are generally no limits on income or age to qualify, and some state plans allow as much as $325,000 to be put into a 529 Plan.

So, is a 529 plan right for you? If tuition is not a concern, you have no tax burden, or your mutual funds are making double-digit returns, maybe not. Otherwise, they are certainly worth considering.

By Mark Johnson