child saving for college

Saving for College: An Overview of 529s

What are they?

529s (qualified tuition plans) are tax advantaged savings plans that were created by congress in 1996 and are authorized by Section 529 of the Internal Revenue Code (which is where they get their name.) They encourage savings for future college costs.

Who Can Start a 529 Savings Plan?

Anyone can start and fund a 529 plan. That includes parents, grandparents, aunts, uncles, friends… you get the picture. You can even start one for your own future education expenses.

Related: The Real Cost of College – The Tale of Two Students

Tax Benefits

Earnings in 529 plans are not subject to federal tax, and in many cases, state tax, as long as the withdrawals are used for eligible college expenses. This means that the gains grow tax free. That’s a big advantage.

However, if you withdraw money from the 529 and don’t use it on college expenses, it will be subject to federal taxes, and an additional 10% federal tax penalty on earnings.

Types of 529 Plans

There are two types of 529s: pre-paid tuition and college savings plans.

All 50 states offer at least one type of 529 plan. And some private colleges and universities support a pre-paid tuition plan. Each plan has one designated beneficiary:  the child whose education you are saving for. Whoever purchases the 529 controls the funds until they are withdrawn.

What’s the difference?

Generally, pre-paid plans allow the saver to purchase units or credits and participating colleges and universities either in a lump sum or by making payments over time. College savings plans are investments. They are therefore subject to market risk. You could lose money.

Comparing Plans

All pre-paid plans differ depending upon the state and/or educational institution that offers them.

All college savings plans differ depending upon the type of plan and investment options chosen.

 

Pre-Paid Plans
College Savings Plans
Locks in tuition prices Does not lock in tuition prices
Covers tuition and fees only Covers all higher education related expenses
Most are guaranteed by the state Are not guaranteed by the state
Have age limits for beneficiaries Do not have age limits for beneficiaries
Require state residency Do not require state residency
Have a limited enrollment period Do not have a limited enrollment period
Availability depends on your state Many of these plans may only be available through brokers.

Important Things to Consider

Both types of 529 plans are considered parental assets in the financial aid calculation of the expected family contribution toward college costs. A 529 plan could lower a student’s eligibility for need-based financial aid.

Pre-paid Plans

Pre-paid plans in most states allow you to lock in a tuition rate at the time of the investment. This is the best feature of pre-paid plans as tuition costs increase overtime. The downside? Your kid may not want to attend the college covered by the plan.

While most pre-paid plans will pay out the amount you invested less interest, you also may be subjected to cancellation fees when you cash out. Also, pre-paid plans generally only cover tuition. You will need to consider other means to cover room, board, books and other educational related expenses.

College Savings Plans

By comparison, college savings plans allow you to use the money for any higher institution, and they cover all educational expenses including room, board, books and even computers.

However, college savings plans are investments and are therefore subject to market risk. They are also subject to fees. And these fees can be very confusing because they can depend not only on the type of plan but also vary within the plan itself.

A single college savings plan can offer more than one “class of shares” to investors. These are often referred to A, B or C classes and they come with different fees and expenses. This can make a huge difference in the value of your investment overtime as your returns can be gobbled up by fees and expenses.

So be careful and do your research!

If you buy a plan through a broker or financial advisor, ask them to explain the fee structure and fee impact over time to the overall portfolio.

One other thing to consider: you can buy a 529 college savings plan in a different state if you think that state has a better investment option. However, only a few states allow residents to deduct contributions to all 529 plans from state income tax returns, so you probably won’t get the state tax credit (you’ll get the federal tax credit).

Related: Start Impact Investing for $50

Where Do I Find 529 Plans?

  1. Most 529s offer program descriptions and fee disclosures, called circulars. Circulars are publicly available on the collegesavings.org website created by The National Association of State Treasurers. The website is user friendly and can guide you to what is currently being offered by your state.
  2. You can also check out The U.S. Securities and Exchange Commission for a more in-depth explanation of the types of fees to look out for in college savings plans.
  3. If you want to dig deep into the underlying mutual funds in a college savings plan, you can check out the U.S Securities and Exchange Commission’s data base EDGAR.
  4. If you want to check up on a specific broker, go to the Investment Advisor Public Disclosure site.
  5. You may also find the Financial Industry Regulatory Authority (FINRA) site helpful in seeking additional means to save for college.
The bottom line is that you owe it to yourself to thoroughly understand these plans before signing up.

Do your research, be honest with yourself about your financial situation and don’t be afraid to ask questions. Only you can decide whether a 529 plan would benefit you, or whether you should look at other types of investments for college savings.  

 

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