A 529 plan is a special kind of investment account designed for college saving. Money grows in the account tax-deferred, and the earnings become tax-free if withdrawn and used for college expenditures.
Here's how the accounts work:
Deposits into the account do not qualify for a federal tax deduction, however some states allow deductions for 529 deposits.
Earnings grow without current taxation.
Withdrawals for tuition, books, room, and board qualify for tax-free status.
529 plan money can be used at any accredited college or university.
The donor maintains control of the account, including how the money is invested and when it is disbursed.
The donor can reclaim the money in the account at any time (however, non-taxed earnings withdrawn by the donor and not used for college expenses are subject to income tax and a 10% penalty).
529 plan money gets favorable treatment on annual FAFSA forms. Even though the child is named as the beneficiary of the account, the 529 account is considered to be a parent asset and thus is not included with the student assets on the FAFSA.
The beneficiary of the account can be changed without penalty, so if one child decides not to go to college or doesn't need all the money that is in the account, the beneficiary can be changed to another child with no loss of tax breaks.
Contribution limits are high – as high as $300,000 in many plans.
No gift tax for contributions up to $60,000 per beneficiary in a single year, assuming no other gifts to beneficiary.
Read the fine print. Some 529 plans charge management hefty fees.
Each state has state-sponsored 529 plans, however anyone from any state can invest in a plan in any state. Therefore, it's sensible to compare 529 plans from all the states. This may seem daunting, but there's help available. Joe Hurley's Savingforcollege.com web site offers a comparison program that allows you to pit plans from every state against each other to determine what plan is the best match for you.
In some states, funding a 529 plan at a certain level locks in the cost of four years of college tuition at a state college. And many state colleges offer prepaid tuition programs that also lock in the costs. With college costs constantly on the rise, this can be a valuable benefit. Some states offer matching contributions to 529 plans.
Consider the Independent 529 Plan, a plan that allows you to lock in the costs at any of 260 colleges and universities nationwide.
Look at the investment options when picking a 529 plan. Each plan has its own array of options. Different plans will appeal to different people, depending on how long your money will be invested and what types of investments are comfortable to you.