Saving for College: 529 Accounts
September 26, 2011
By Sean Naron, Consumer Federation of America Advocacy Associate
Recently, America Saves reached out via Facebook and Twitter to find out some common questions people had about saving more successfully. With schools finally back in session and the official start of fall right around the corner, many concerned parents have asked about college savings plans, specifically, the benefits of what is commonly known as a 529 savings plan.
What is a 529 plan?
Originally designed to be the collegiate equivalent of a 401(k), a 529 qualified tuition program (QTP) is a state administered tax-advantaged investment plan designed to allow families to prepare for the cost of college over a period of time.
Every state has a 529 plan, and each is different. Depending on your plan choice, you can invest in your state’s plan or another state’s plan; however there are certain benefits for in-state participants.
How Does it Work?
There are two main types of 529 plans: the pre-paid plan and the investment savings plan.
- The pre-paid essentially allows families to purchase university credits at current tuition levels and store them for future use. These plans are often guaranteed by the state.
- The second college savings plan is an investment portfolio for the future student. At first, the portfolio is based primarily on stocks, but as the time for college nears, the plan shifts more heavily toward bonds. These plans are more flexible, but can be more risky, as they are based on stock market performance.
What are the Benefits?
The main benefit of a pre-paid 529 plan is that it locks in tuition at current rates. Again, these rates are often, but not always guaranteed by the full faith and credit of the state. Prepaid tuition plans are also exempt from federal income tax, and are often exempt from state and local income taxes.
The primary advantage of 529 investment plan is tax-free investment growth and tax-deferred compounding. Earnings from 529 investment plans can also be withdrawn tax-free when used for qualified higher education expenses. In addition, investing with your own state's 529 may get you additional state-tax deductions on contributions or exemptions on withdrawals.
What Does the Plan Cover?
Generally, funds in a prepaid 529 plan cover only tuition and university fees, while funds from a investment savings plan can be used for any traditional, qualified educational expense. This includes tuition, room and board, books, supplies, and other applicable university fees.
What Could Go Wrong?
With a large number of 529 plans flooding the market, it has become increasingly difficult to determine the right plan for your family. Because there are so many choices, it is incredibly important to do your research before choosing a 529 plan.
If you use a 529 investment plan, you must also be aware of the possibility of actually losing money long term, depending on the investment performance of your account.
Is This for Me? Which Plan is Best?
There is no perfect college savings plan. The most ideal plan is entirely dependent on your individual situation and financial outlook.
If you think a 529 plan might be for you, we highly recommend doing plenty of research as well as speaking with a broker to determine the best plan of action for your family.
Some Great Resources:
Savingforcollege.com hosts a list comparing multiple state 529 plans.