The 529 plan is a college savings plan designed to help families set aside funds for future college expenses. The 529 plan originate within states or institutions, rather than the federal government (such as with college loans). With tuition costs rising rapidly every year, states have created funds (the original model being Michigan) in which state residents can pre-purchase college credits for the future, which go into a guaranteed savings pool.

These savings can be used for tuition, books, and other education-related expenses at accredited colleges and universities. Even educational institutes can offer the prepaid 529 savings plans, but not the regular savings plans; you must attain those from a financial institution. While these plans are administered at the state level, they are allowed by a section in the Internal Revenue Code 26, section 529.

What are the Two Types of 529 Plans?

There are two types of 529 plans. Every state has at least one of these two choices; some have both.

• Prepaid plans — Buying future tuition at today’s rate. The program pools the money and invests on a large scale, with a guaranteed payout.
• Savings plans — Provides a variable rate of return usually based on stock or bond funds, but is subject to market risks.

There is a misconception that state-sponsored 529 plans are only intended for families that send their kids to a state school. Not true. The prepaid tuition plans will let you transfer the value of your contract to private and out-of-state schools (depending on state). The regular savings plans, however, have no such restrictions, but they must be used on an accredited school.

What are the Benefits of a 529 Plan?

You are in control

You make the contributions, so you are in control of the account; the beneficiary has no rights to the fund. You can pull it all out at any time (you will incur a 10% penalty tax though). You may also change the beneficiary at any time.

Income tax breaks

Contributions are not deductible on your federal return; however, your investment grows tax-deferred, so basically it becomes federally tax-free. Your own state may have additional perks, such as offering upfront deductions.

Flexible

Anyone is eligible to utilize a 529 plan. Plus, the amounts you can put in are substantial; $300,000 per beneficiary in many states. There are no income limitations and no age restrictions, making them great for grandparents wanting to help save for their grandchildren’s future.

Is a 529 an Asset?

Thankfully, in the 2006 Deficit Reduction Act of 2005, a law was enacted that prevents 529 plans from being figured in the federal student aid eligibility formula. That means your 529 plan will not be treated as an asset. This is great news for those filling out FAFSA and hoping for the most financial aid opportunity.  Now keep in mind, your particular school may still set their own rules when handing out need-based scholarships when they discover 529 accounts in the family.

There is one piece of sort-of bad news: contributions are treated a gift to the named beneficiary for gift tax. The good news is that it also qualifies for the $13,000 annual gift tax exclusion, so most people will not incur the gift tax every year. Another way around that is to do that five-years worth of “gifts” in one year and you will not incur any gift tax, but remember you can not contribute for the following 4 years to that beneficiary.

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