529 plans are one of the more popular options for families saving for their child's college education. Although the plans do differ from state to state, they are all exempt from federal income tax, giving you a real boost to your college fund.
What is a 529 plan?
A 529 plan is a state-operated plan that gives families a federal tax-free way to save money for college. Specific plan attributes vary by state but all have several common features.
What are the two types of 529 plans?
Just about every state now has at least one of these two options and many states offer both.
Plan details for both types of 529 plans:
Earnings and withdrawals are exempt from federal taxes as long as they are for paying college-related costs.
Deductibility for state income tax varies from state to state.
If funds are withdrawn for purposes other than education, they are subject to a 10% penalty and federal income tax. Implications to state taxes varies by state.
Most states hire experienced investment companies to manage their 529 accounts.
Note: Each state's 529 plan has its own set of rules and restrictions. Be sure to request the most recent plan details from plan administrators. For information about the plans for any state, click here.
A qualified, nontaxable distribution from a 529 plan now includes the cost of the purchase of any computer technology, related equipment and/or related services such as Internet access. The technology, equipment or services qualify if they are used by the beneficiary of the plan and the beneficiary's family during any of the years the beneficiary is enrolled at an eligible educational institution.
Which type of 529 plan is right for you?
It depends on your needs. In a nutshell, college savings plans give you more options but you assume more risk, while a prepaid tuition plan eliminates your risk but also limits your options.
|College Savings Plan
||Prepaid tuition plan
|Good for college expenses at any public or private college.
||Good for college expenses at public schools in the state managing the plan. However, some states have reciprocal agreements between them which provides more options.
|Are not required to be a resident of the state to participate.
||Must be a resident of the state to participate.
|Savings are treated as an asset of the parent when determining financial aided, which means that only 5.6% or less of the account's value is factored into calculating the Expected Family Contribution (EFC) for each academic year.
||Can significantly reduce a family's eligibility for financial aid. Distributions paid to the college are treated like scholarships, reducing a family's need figured on a dollar-for-dollar basis.
|Not guaranteed to make a profit and can actually lose money . There is no guarantee that you will have enough funds to pay for any portion of your expected college costs.
||Since you are essentially paying for college credits, you are guaranteed to have sufficient funds for whatever portion of the tuition you have prepaid.
|You generally have investment options that are higher risk, providing you with the possibility of outpacing the market value of a like investment in a prepaid tuition plan.
||Less risk so therefore less return, but you know exactly what you have when your child needs the funds for college.
|Broad range of college-related expenses are allowed.
||For some state plans funds can only be applied to tuition and fees. Expenses such as room and board, course fees, books are not included. Other state plans allow funds to be used for such expenses if a family ends up with excess tuition units or if tuition and fees are reduced by scholarships.
|Very large contributions are allowable; up to $250,000 in some states.
||Contributions are limited.