A 529 plan is a tax-deferred vehicle used to save for educational expenses. I like to think of them as Roth IRA’s for college. The plans have evolved over the past 20 years into their present form which was enacted in 2001. Today, they are the country’s predominant method used to save for college.
529 plans essentially come in two forms. One is referred to as a pre-paid plan, wherein you pay today’s tuition rates for tomorrow’s college student. Currently, 11 states offer pre-paid plans and each has their own options and services within those plans. In general, the older a child is once you purchase a pre-paid plan the more you’ll end up paying, so it is advantageous to start a pre-paid plan as close to birth as possible.
Pre-paid plans often have strict rules regarding exactly what they pay for and which institutions they may be used. They may not cover housing, particularly off campus, and may not cover the full cost of tuition or some fees. They also might be limited to public schools within the state where they are purchased. With all that being said, it is important to carefully consider and understand the rules of any given pre-paid plan.
The other form of 529 plans is traditional savings plans. In these, money is invested in stocks, mutual funds, bonds, or other investment vehicles. You’ll pay no tax on the earnings of those investments which is the advantage of these plans. 529 Savings plans typically have fewer rules than pre-paid plans and generally are more “universal” in that there are no restrictions on where the money can be used.
The main rule that is associated with saving plans is that the money must be used on what are considered qualified educational expenses. Typically, this includes tuition, books, fees, technology required by the school, and some room and board. If you withdraw money for purposes other than these, you’ll pay a hefty 10% penalty plus income tax on the earnings.
One caveat of 529 saving plans is that each state has their own plan. However, you may invest in any state’s plan whether or not you live there and whether or not you believe your children will ever attend school in that state. So, for example, I live in Florida but have chosen Utah’s plan for my own children.
Each state invests in different funds and has different fee structures; some have state income tax advantages and other perks. Thus, in the end it is best for 529 savings plan customers to compare their own state’s plan with those from other states in order to find the best fit for their family.
Usually, you’ll be able to set up automatic contributions to savings plans from your bank account and, as with pre-paid plans, the earlier in your child’s life you start saving, the less you’ll have to pay for college once your child graduates.
Savingforcollege.org is a private website but is widely considered to be the premiere resource for 529 plans. There, you can view the details of your state’s plans and comparison shop with other states.
