What are 529 Plans?
A 529 plan is a tax-advantaged investment savings plan in the U.S. designed to encourage savings for future college costs for a beneficiary. Per IRS "the 529 are legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code."
The individual 50 state sponsor at least one type of 529 plan and they also determine the allowable investments within the 529 plans itself. More importantly, for a 529 Plan participant there are significant state tax advantages and other benefits, such protection from creditors and exemption from state financial aid calculations, for account holder/investors who invest in 529 plans within their state of residence.
Types of 529 Plans available
There are essentially only 2 types of 529 Plans available. 1. Prepaid:
Allows one to purchase tuition credits and expenses at the present fixed rate to be used in the future. Performance is based upon tuition inflation. 2. Savings:
These are different in that all growth is based upon market performance of the underlying investments, which typically consist of mutual funds.
Most 529 savings plans offer a variety of age-based asset allocation options where the underlying investments become more conservative as the beneficiary gets closer to college-age. They also offer risk-based asset allocation options where the underlying investments maintain the same equity-to-fixed-income ratio regardless of the age of the beneficiary.
Many savings plans also offer a stable value or guaranteed option designed to protect an investor's principal while providing for some investment growth, while others offer investments in certificates of deposit.
his plan offers a monthly systematic investment into the 529 Plan in a low affordable amount that sometimes could be as low as $50 per month. The affordable feature along with regular systematic fixed investment made into the plan in the long run attempts also to minimize market risk, or so the experts say!
What are some of the advantages of having a 529 Plan?
- The invested funds accumulate dividends and capital gains that are essentially exempt from both federal and state. Further, all withdrawals are tax free provided they are used to exclusively fund the beneficiary’s higher education costs.
- The account holder has control over the plan, regardless of the beneficiary’s age.
- The beneficiary can be changed at any time to another person of the beneficiary’s family.
- Money can be used in virtually every college and can be used to pay tuition fees, room and board, meal plans, books, supplies, etc.
- A key financial benefit is that the assets within 529 plans are often protected from bankruptcy within the state offering the plan.
- Most plans have very low minimum monthly contribution limits making them attractive to all families regardless of income level.
Clearly, there are some disadvantages of a 529 Plan. What are some of the disadvantages of having a 529 Plan?
- There are restrictions that apply to an investment in a 529 plan in that under current tax law, an account holder is only permitted to change his or her investment option one time per year.
- Investing in a 529 plan may reduce a student’s eligibility to participate in need-based financial aid.
- A withdrawal for non-education purpose may be subject to income tax on the gains only and an additional 10% federal tax penalty on earnings.
- Of the 45 states that have established plans, 27 of them charge expenses of more than 1% per year and 10 of those states take additional sales loads. These fees are considerably higher than those normally charged in a mutual fund.
- This may not be suitable strategy for someone who has child about to go to college in less than 2-4 years. It would be better to invest in a traditional mutual fund as the fund expenses would be much lower than in the 529 Plans.
I would strongly suggest that you consult a financial planner to determine whether or not this is the best strategy for you, based on the existing tax laws, which are constantly changing.