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529 Plan Basics

Brian Carrozzi October 29, 2013

529 plans are named after section 529 of the Internal Revenue Code 26 U.S.C. § 529. State plans can have significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence. There are no residency requirements on 529 plans. You can invest in any state’s plan, whether you live there or not, and you can draw funds from the plan to pay for college in any state, whether it’s in your home state, the plan’s home state, or another state. Some states do require non-residents to work through brokers to buy into their plans, and that can add some fees and costs to the plan.

There are two types of 529 plans, prepaid plans and savings plans:

Prepaid Plans

  • Prepaid plans allow you to purchase tuition credits at today’s rates to be used in the future.
    • Prepaid plans can be administered by states or higher education institutions.
    • Currently, eleven states provide prepaid tuition plans.

Savings Plans

  • Savings plans are different in that all growth is based upon market performance of the underlying investments, which typically consist of mutual funds.
  • Most 529 savings plans offer a variety of age-based asset allocation options where the underlying investments become more conservative as the beneficiary gets closer to college age.
  • Savings plans may be administered by states only.

Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some international universities.

Distributions and Taxes

A distribution from a 529 plan that is not used for the above qualified educational expenses is subject to income tax and an additional 10% early distribution penalty on the gains portion only unless one of the following conditions is satisfied:

  • The designated beneficiary dies, and the distribution goes to another beneficiary or to their estate.
  • The designated beneficiary becomes disabled.
  • The designated beneficiary receives educational assistance from an employer or a qualified scholarship.

529 plans are an easier hands off way to invest for your children’s education. In addition, if you have a state plan with additional tax saving benefits, the 529 plan can be a great way to earn tax free returns and also not pay tax on qualified distributions if your states plan is structured that way.

Who Controls Your 529 Plan?

Lastly, 529 plans are controlled by brokers and custodians. The child does not have access or control of the account so this makes this type of college savings plan more protected since there is more control over access to the account. With other types of accounts, the child may have access to it and withdraw funds that should be for college for something else.

529 plans can be a powerful tax advantaged way to save for college. Explore 529 plans in your state to see if you can take advantage of them or find another state nearby to open an account with if they have more tax benefits.

Disclaimer: Please seek professional advice regarding tax liability and investing options based on your personal situation.

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