If you are looking for a versatile college savings plan for a child in your life, you may find yourself considering a 529 account. A 529 savings plan allows you to save for future college costs, while also giving you a tax benefit. Legally called “qualified tuition plans,” these savings plans are authorized by section 539 of the Internal Revenue Code. 529 programs are sponsored by educational institutions, states, or state agencies.
Every state and the District of Columbia all sponsor at least one of the two types of 529 plans. The two different types of plans are prepaid tuition plans or college savings plans. If you have hopes of sending your child to a private university or college, there are some institutions that offer prepaid tuition plans.
This article will explain the different 529 accounts, costs, tax benefits, restrictions, and financial aid.
College Savings Plans vs. Prepaid Tuition Plans
While the prepaid tuition plan and the college savings plan both have several benefits, determining which is the best 529 plan for you will largely depend on where you live. Different states have different plans. Here is a breakdown of the two different types of plans.
College Savings Plan
College savings plans are an investment account that allows people to save money for their children’s future qualified school expenses. Examples of eligible expenses include tuition, room and board, and any school required fees.
There are various investment options that include mutual fund an exchange-traded funds (EFT, and a principle-protected bank product. The portfolios can consist of static fund or age-based portfolios. The age-based portfolios start out more liberal and then shift toward conservative investments as the child gets older.
Even though the college savings plan is a state-based 529 account, most of them can be used at most schools nationwide, and even at some non-U.S. colleges and universities. It is essential to double-check the specifics though because there are a few 529 accounts that have residency requirements. College savings plans are not federally funded; however, some of the bank products are insured by the FDIC.
One of the more important things to know about a college savings plan is that they are similar to other investments which mean you run the risk for not making any extra money or possibly losing any of it you invested.
Prepaid Tuition Plan
Prepaid tuition plans allow people to purchase credits, or units, at the college or university that go toward the tuition and fees costs of a future student. One significant difference between the prepaid tuition plan and the college savings plan is that prepaid tuition plans do not cover room and board most of the time.
Prepaid tuition plans are state government sponsored, but they differ from college savings plans because they have residency requirements. Prepaid tuition plans do not have a guarantee from the federal government, but there are some state governments that will guarantee any money paid into the accounts they sponsor.
One of the riskier parts of a prepaid tuition plan is that there are some strict guidelines and potential for loss. If the sponsor of the plan experiences a financial crisis, there is a chance you will lose some or all of the money you paid. If the beneficiary decides to attend a college or university that doesn’t participate in the college choice 529, your plan may pay less than it will for a participating school.
Fees and Expenses of 529 Accounts
While the potential fees and expenses of 529 accounts will differ based on the type of plan you choose, it is important to review the plan’s specific details to understand what you will be charged for the plan, and for the different investment options.
Fees for Prepaid Tuition Plans
Prepaid tuition plans may have enrollment or application fees to start, and administration fees charged throughout.
Expenses for College Savings Plans
Similar to prepaid tuition plans, there may be enrollment or application fees for college savings plans. Also, there may be program management fees, annual fees for account maintenance, and asset management fees charged at regular intervals. For college savings plans, some of the fees are collected by the state which sponsors the plan, and other fees are received by the manager of the plan.
The amount and type of fees will depend on which investment option you choose. If you set up a plan through a broker, you may have extra fees that are assessed when you invest or redeem or ongoing fees for distribution.
Tips for Saving Money
When you are researching 529 plans, there are some opportunities to save or reduce fees, to help more of your money go to the plan. Many states have college savings plans called direct-sold, and those plans will reduce or waive administrative fees or maintenance fees for people who keep a large account balance, set up an automatic contribution to your plan, or are a resident of the state where you are purchasing the plan.
Many states will also waive fees if your plan is set up for colleges or universities that accept electric only or online delivery of documents.
Federal and State Tax Implications for 529 Accounts
There are many situations where investment into a 529 account will present special tax benefits. Understanding the effect your 529 accounts will have on your taxes is important. Some people opt to hire a tax advisor to help guide them through taxes. Contributions and withdrawals are the two actions that are important for tax purposes.
A lot of states offer tax benefits when you contribute to a 529 plan. Some of the benefits include deductions from your state income tax or matching grants you can utilize. One important point to note is that many college saving plans are only eligible for benefits if they are donating to a plan sponsored by the state where they live.
There are two different kinds of withdrawals: for college or not for college, and the tax implications are different depending on why you are withdrawing. If you are withdrawing to pay for qualified higher education costs, earnings are not typically subject to federal or state income tax; however, if you withdraw for any other purpose, you will be subject to both federal and state income taxes plus an additional 10 percent penalty for the earnings.
Restrictions on 529 Plan Investments
There are rules and restrictions on all 529 accounts, and it is crucial to read the plan’s details to ensure you understand and are comfortable with all of the specifics. Most restrictions involve investments and withdrawals. Here is more on each of them.
One of the most common restrictions of a 529 account has to do with investments. Most college savings plans have specific investment options and under current tax law, switching between investment options is only an option when there is a beneficiary change or twice a year.
In most cases, you can only withdraw the money you invest in a college savings plan for qualified education expenses without penalties and taxes. The beneficiary of the plan is the only one who can use the funds, and only at participating schools.
For beneficiaries who don’t attend a participating school or decides to not go to school, the plan may only pay out a small portion of the original investment amount.
Financial Aid and 529 Plans
Financial aid is important for many students, and it is important to understand how 529 accounts will impact financial aid before going to school. Each college or university will treat 529 accounts differently, but in most cases, 529 plans will affect the eligibility of financial assistance for the student.
While the student may not qualify for the same financial aid package as someone without a college savings plan, most financial aid packages are primarily made up of loans so students who have a savings account will accrue less debt if more is saved beforehand.
Doing some research or sitting down with a financial advisor at the educational institution you are considering is an excellent way to clear up any questions.
Every 529 plan has an offering circular that will give you all of the specific details about the plan you are considering. To find more information about most of the 529 plans offered, the National Association of State Treasurers provides links in its College Savings Plan Network. When you are figuring out the specifics of the plans you are considering; you can access a 529 calculator and a tool for comparing the details of the different plans at Financial Industry Regulatory Authority (FNRA).
College savings plans are a good option for many people. They allow people to split up the staggering college costs over several years, making it easier to afford for many people. To get started, research what types of 529 plans are offered in your state, and what fees and expenses you can expect. While there are restrictions and fees, there are typically many different plans, and one of them may work for you.