Two Types of 529 Plans
The savings plans known as Section 529 plans are set up under the Internal Revenue Code Section 529 (hence the name) as part of the 2001 Tax Relief Act. There are two main types of Section 529 plans—prepaid tuition plans and college savings plans. When these plans were first implemented, many states offered the prepaid tuition option to their residents. Unfortunately, the average rate of increase for college tuition was greater than the growth rate of funds in these plans. Because the prepaid plan couldn't keep up with these tuition increases, states began to move away from this option.
These days, most Section 529 plans are college savings plans, which are very similar to just about any other type of investment vehicle. You put your money into the plan and (hopefully) watch it start to grow. Section 529 plans may not achieve the highest of returns on your invested money; on the plus side, however, the tax benefits are quite substantial.
Advantages of College Savings Plans
In terms of the FAFSA and other applications for financial aid, college savings plans are also treated with a certain amount of favor. Prepaid tuition plans are counted as a resource in the student's financial aid package (and, therefore, might bring the total high enough to disqualify the student for certain other types of financial aid). A college savings plan, on the other hand, is counted as an asset of the account holder—usually the parent. Consequently, the funds are not considered a part of a student's financial aid package, even though they are applied to education costs. This helps keep the total of the financial aid package low enough so that the student might still qualify for certain other types of aid. Assets, including a college savings plan, are included in the EFC calculation, but not at 100 percent.
Each of the fifty states is currently participating in Section 529 plans for college tuition assistance. This means that no matter where you live or attend school, they are there to be found.
A college savings plan may provide you with more options than a prepaid tuition plan because it gives you greater flexibility in your choice of colleges. This is a significant advantage when you consider that a savings plan can start ten to fifteen years (sometimes more) before the college selection process is actually underway.
Common Traits of Section 529 Plans
No matter which type of Section 529 plan you end up with, there are some important features you should know about. It is always good to know as much as you can when it comes to investment planning. If you know what you're getting into, you're less likely to get blindsided later on. Here are some of the basic facts about Section 529 plans:
Earnings from Section 529 plans are exempt from federal taxes, as are withdrawals used for paying college costs.
Some states also waive state tax for residents, while others allow deductions on contributions.
Section 529 plans have generous maximum contribution limits, as much as $250,000 per beneficiary.
Most states hire investment companies to manage these plans, for maximum investment efficiency and return.
Funds withdrawn for purposes other than education are subject to a 10-percent penalty and to federal income taxes. (States assess their own penalties.)
Remember that Section 529 plans change depending upon your state of residence. Depending on where you live, some of the above factors may not apply. However, being aware of the most common factors will at least empower you to ask your Section 529 plan provider about which of these traits will apply to your specific situation.
Get the Grandparents Involved!
Section 529 plans are a really good idea for parents who are saving for a child's college education. They also allow for contributions by grandparents and anyone else who wants to help. Saving money now could mean borrowing a lot less money later (which translates into a lot less to be paid back—with interest). With Section 529 plans, grandparents enjoy a tax benefit while providing their grandchildren money to help pay for education.
Section 529 plans have grown into one of the most popular methods for families to start saving for their children's college education. Though these plans may be different from one state to another, they are all exempt from federal income tax, and that could translate into one heck of a contribution to a student's college fund.