529 - College Savings Plans

529 college savings plans are tax-advantaged college savings vehicles and one of the most popular ways to save for college today. Much like the way 401(k) plans revolutionized the world of retirement savings a few decades ago, 529 college savings plans have revolutionized the world of college savings. As of June 2020, total assets in college savings plans reached an all-time high of $425 billion. (Source: College Board’s Trends in Student Aid 2020)

Tax advantages and more

529 college savings plans offer a unique combination of features that no other college savings vehicle can match:

  • Federal tax advantages: Contributions to your account grow tax
    deferred and earnings are tax free if the money is used to pay the
    beneficiary’s qualified education expenses. (The earnings portion of any
    withdrawal not used for college expenses is taxed at the recipient’s
    rate and subject to a 10% penalty.)
  • State tax advantages: Many states offer income tax incentives for
    state residents, such as a tax deduction for contributions or a tax
    exemption for qualified withdrawals.
  • High contribution limits: Most plans let you contribute over $520,000 over the life of the plan.
  • Unlimited participation: Anyone can open a 529 college savings plan account, regardless of income level.
  • Professional money management: College savings plans are offered by
    states, but they are managed by designated financial companies who are
    responsible for managing the plan’s underlying investment portfolios.
  • Flexibility: Under federal rules, you are entitled to change the
    beneficiary of your account to a qualified family member at any time as
    well as rollover the money in your 529 plan account to a different 529
    plan once per year without income tax or penalty implications.
  • Wide use of funds: Money in a 529 college savings plan can be used
    at any college in the United States or abroad that’s accredited by the
    Department of Education and, depending on the individual plan, for
    graduate school.
  • Accelerated gifting: 529 plans offer an excellent estate planning
    advantage in the form of accelerated gifting. This can be a favorable
    way for grandparents to contribute to their grandchildren’s education.
    Specifically, individuals can make a lump-sum gift to a 529 plan of up
    to $75,000 ($180,000 for married couples) and avoid gift tax, provided
    the gift is treated as having been made in equal installments over a
    five-year period and no other gifts are made to that beneficiary during
    the five years.

Choosing a college savings plan

Although 529 college savings plans are a creature of federal law,
their implementation is left to the states. Currently, there are over 50
different college savings plans available because many states offer
more than one plan.

You can join any state’s 529 college savings plan, but this variety
may create confusion when it comes time to select a plan. To make the
process easier, it helps to consider a few key features:

  • Your state’s tax benefits: A majority of states offer some type of
    income tax break for 529 college savings plan participants, such as a
    deduction for contributions or tax-free earnings on qualified
    withdrawals. However, some states limit their tax deduction to
    contributions made to the in-state 529 plan only. So make sure to find
    out the exact scope of the tax breaks, if any, your state offers.
  • Investment options: 529 plans vary in the investment options they
    offer. Ideally, you’ll want to find a plan with a wide variety of
    investment options that range from conservative to more growth-oriented
    to match your risk tolerance. To take the guesswork out of picking
    investments appropriate for your child’s age, most plans offer
    aged-based portfolios that automatically adjust to more conservative
    holdings as your child approaches college age. (Remember, though, that
    any investment involves risk, and past performance is no guarantee of
    how an investment will perform in the future.)
  • Fees and expenses: Fees and expenses can vary widely among plans,
    and high fees can take a bigger bite out of your savings. Typical fees
    include annual maintenance fees, administration and management fees
    (usually called the “expense ratio”), and underlying fund expenses.
  • Reputation of financial institution: Make sure that the financial
    institution managing the plan is reputable and that you can reach
    customer service with any questions.

With so many plans available, it may be helpful to consult an
experienced financial professional who can help you select a plan and
pick your plan investments, giving you peace of mind. In fact, some 529
college savings plans are advisor-sold only, meaning that you’re
required to go through a designated financial advisor to open an
account. Always carefully read the 529 plan issuer’s official materials
before investing.

Account mechanics

Once you’ve selected a plan, opening an account is easy. You’ll need
to fill out an application, where you’ll name a beneficiary and select
one or more of the plan’s investment portfolios to which your
contributions will be allocated. Also, you’ll typically be required to
make an initial minimum contribution, which must be made in cash or a
cash equivalent.

Thereafter, most plans will allow you to contribute as often as you
like. This gives you the flexibility to tailor the frequency of your
contributions to your own needs and budget, as well as to systematically
invest your contributions. You’ll also be able to change the
beneficiary of your account to a qualified family member (e.g.,
siblings, stepsiblings, parents, nieces, nephews, aunts, uncles, first
cousins) with no income tax or penalty implications. Most plans will
also allow you to change your investment portfolios (either for your
future or current contributions) if you’re unhappy with their investment
performance.

529 prepaid tuition plans–a distant cousin

There are actually two types of 529 plans–college savings plans and
prepaid tuition plans. The tax advantages are the same, but the account
features are very different. A prepaid tuition plan lets you prepay
tuition at participating colleges at today’s prices for use by the
beneficiary in the future. The following chart describes the main
differences:

College Savings PlansPrepaid Tuition Plans
Offered by statesOffered by states and private colleges
You can join any state’s planState-run plans require you to be a state resident
Contributions are invested in your individual account in the investment portfolios you have selectedContributions are pooled with the contributions of others and invested exclusively by the plan
Returns are not guaranteed; your account may gain or lose value, depending on how the underlying investments performGenerally a certain rate of return is guaranteed
Funds can be used at any accredited college in the U.S. or abroadFunds can only be used at participating colleges, typically state universities

Note: Investors should consider the
investment objectives, risks, charges, and expenses associated with 529
plans before investing. More information about specific 529 plans is
available in each issuer’s official statement, which should be read
carefully before investing. Also, before investing, consider whether
your state offers a 529 plan that provides residents with favorable
state tax benefits.