DEFINITION of 529 Savings Plan
A tax-advantaged method of saving for future college expenses, authorized by Section 529 of the Internal Revenue Code. Legally known as “qualified tuition plans,” 529 Savings Plans are sponsored by states, state agencies or educational institutions, and may be used to cover a recipient’s tuition, room, board, books, computers and other expenses. The money contributed to the account may be invested in equity or fixed income mutual funds, as well as money market funds, exchange-traded funds (ETFs) and a principal-protected bank products. In most cases, the earnings are not subject to federal or state taxes, provided the money is used only for qualified college expenses. The plans are open to both adults and children beneficiaries.
BREAKING DOWN 529 Savings Plan
Each U.S. state has its own 529 savings plans, replete with a unique set of features. Individuals living in all states may open a 529 Plan, but the plan does not have to be in the account holder's or the designated beneficiary's state of residence.
There are two different kinds of 529 plans: Prepaid Tuition Plans and College Savings Plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan, however a group of private universities participate in Prepaid Tuition Plans. With Prepaid Tuition Plans, the account holder buys credits at participating colleges and universities, covering future tuition costs, but locking them in current prices. Typically offered by in-state, public academic institutions, Prepaid Tuition Plans usually may not be used for future room and board and other ancillary expenses. The federal government does not guarantee prepaid plans and while only certain state governments guarantee the money paid into plans they sponsor, which account holders may lose, if the underlying investments experience a drop in value. College Savings Plans let account holders open an investment account to save for the beneficiary’s future qualified higher education, that includes room and board, as well as the tuition fees.
College savings plan accounts generally apply to any university, including non-U.S. institutions of higher learning.
It’s important to recognize that fees associated with 529 plans may lower returns, and that fees may vary depending on whether the type of 529 plan in question is a College Savings Plan or Prepaid Tuition Plan. Therefore, it is incumbent on account holders to investigate the fee structure before setting up either plan, in order to fully understand the terms of each investment option. Both plans may charge application fees and ongoing administrative fees.