What is a '529 Plan'

529 is a category of plans that provide tax advantages when saving and paying for higher education. There are two major types, pre-paid tuition plans and savings plans. Pre-paid tuition plans allow the plan holder to pay for the beneficiary's tuition and fees at designated institutions in advance. Savings plans are tax-advantaged investment vehicles, similar to IRAs. Rules governing the plans are laid out in Section 529 of the Internal Revenue Code. They are legally referred to as "Qualified Tuition Programs" and sometimes called "Section 529 plans."

BREAKING DOWN '529 Plan'

There is no limit on the number of 529 plans an individual can set up, but contributions cannot exceed the cost of education. Distributions from all 529 plans are exempt from federal income taxes, although contributions are not deductible. Annual contributions of over $14,000 are subject to federal gift taxes.

The market for plans is competitive, and most states do not require the plan holder to be a resident or the beneficiary to attend an institution in the state. However, some pre-paid plans do have these requirements. States' plans generally offer their own tax benefits. For the most part these perks only benefit residents, but a few states match the benefits of whatever plan a resident opts for.

Eligible expenses vary depending on the plan. Tuition costs and mandatory fees can always be covered by distributions. Savings plans can be applied to room and board, textbooks and some computer equipment. A few pre-paid plans apply to room and board. 529 plans cannot be used to pay for student loans. Distributions that are not used to pay for qualified educational expenses are subject to taxes and a 10% fee, with exceptions for circumstances such as death and disability.

Ownership

The assets of a plan belong to the plan holder, not the beneficiary (although these can be the same person). The beneficiary has no claim on the assets, which can be withdrawn by the holder for any reason at any time, with penalties. A plan can be transferred to a member of the beneficiary's family, or excess funds can be rolled over into a family member's plan. Neither action triggers a penalty or taxes. Although the beneficiary does not control the plan's assets, these may affect his or her financial aid eligibility to a significant degree. The plan's assets are generally not counted as part of the plan holder's estate, so 529 plans confer estate tax benefits.

Savings Plans

Savings plans, which are only offered by states, are similar to IRAs in that they are tax-advantaged ways to invest money in the long term. Plan holders usually have the option to invest in a range of mutual funds. These funds may be targeted to the date beneficiary is expected to start their education and attempt to reduce risk exposure as the date approaches.

Pre-paid Tuition Plans

Pre-paid tuition plans are offered by states and higher education institutions. In a way, they're analogous to futures contracts: they allow the plan holder to prepay for one or more semesters at designated colleges or universities at current prices. This shields them from inflation in tuition costs, which has historically been much steeper than broader measures of inflation. 

Pre-paid plans differ in their specifics, but often have limitations that do not apply to savings plans, such as age caps and residency requirements. They often have stricter limits on what expenses they can cover: textbooks or room and board may not be eligible. On the other hand, some are guaranteed by states, while savings plans are subject to market risk.

There is one non-state pre-paid plan, called the Private College 529 Plan (formerly the Independent 529 Plan), which allows holders to prepay tuition for a consortium of private schools. One problem with this plan, as with state plans, is that the choice of schools is limited. If the beneficiary does not attend one of the selected schools, the funds may be rolled over into another plan, causing them to forfeit most of their gains. Alternatively, they can be transferred to a family member of the beneficiary or rolled over into that beneficiary's plans, which involves no penalty.

RELATED TERMS
  1. 529 Savings Plan

    A tax-advantaged method of saving for future college expenses ...
  2. 529 Prepaid Tuition Plan

    A tax-advantaged method for paying future college tuition costs ...
  3. Prepaid Tuition Program

    One of the two major types of 529 plans. Prepaid tuition plans ...
  4. Variable Benefit Plan

    A type of retirement plan in which the payout changes depending ...
  5. Qualified Retirement Plan

    A plan that meets requirements of the Internal Revenue Code and ...
  6. Plan Participant

    A plan participant either contributes into a pension plan or ...
Related Articles
  1. Managing Wealth

    Choosing The Right 529 Education Savings Plan

    Before you fund one of these education-savings vehicles, be sure you know their differences.
  2. Personal Finance

    Stop Procrastinating! Enroll In A College Savings Plan

    The cost of sending your kids to college could be a serious financial burden - unless you get prepared. Now.
  3. Financial Advisor

    Using 529 Plans to Save for College

    Paying for college is no easy feat. Here is a lowdown on 529 plans, the educational savings plans that help families set aside funds for college costs.
  4. Investing

    Spoil Your Grandkids, Cut Your Tax Bill

    Helping your grandchildren save for college is a way to spoil them and reap some benefits yourself.
  5. Managing Wealth

    529 Risks to Take (Or Not)

    Six risks to take into consideration when you're managing the 529 plan that lets you put away tax-advantaged money to help your kids pay for college.
  6. Managing Wealth

    A 529 Plan Fit For An Ivy League Education

    The Independent 529 plan offers a unique investment for those wanting to send their kids to the best colleges in the U.S.
  7. Managing Wealth

    How And When To Switch Your 529 Plan

    Just as with any investment, you should review your plan to make sure it's meeting your needs.
  8. 4 Smart 529 Plan Alternatives to Consider

    Learn about some alternatives to the popular college-saving 529 plan that may also make sense, such as prepaid tuition plans and Coverdell accounts.
  9. Financial Advisor

    Advising FAs: Explaining College Savings Accounts to Clients

    There are several types of savings accounts designed for higher education available today. The right one for you will depend upon factors such as your tax bracket, time horizon, investment objectives ...
RELATED FAQS
  1. 529 plans may do all of the following except: a) As a prepaid tuition plan ...

    Free info on financial certification exams including study guides, exam questions, and much more! Read Answer >>
  2. Can 529 plans be used to transfer wealth to other family members if the original ...

    Yes, the 529 plan (also known as a "qualified tuition program") allows you to distribute and roll over funds from one 529 ... Read Answer >>
  3. Who benefits the most from prepaid expenses?

    Learn who benefits most when expenses are prepaid. Individuals and businesses often make payments, such as rent or insurance, ... Read Answer >>
  4. Are 457 plan withdrawals taxable?

    Learn how withdrawals from 457 deferred compensation plans are taxable but are not subject to the same rules and restrictions ... Read Answer >>
  5. What is the difference between a 401(k) plan and a 457 plan?

    Discover how 401(k) plans are privately offered employee retirement plans, while 457 plans are typically available to public ... Read Answer >>
  6. Is an IRA a qualified plan?

    Learn about the definition of a qualified retirement plan and some of the features and benefits of individual retirement ... Read Answer >>
Trading Center