A 529 plan is a tax-advantaged investment plan designed to help families to save for a beneficiary’s (typically one’s child or grandchild) future higher education expenses. While commonly referred to as 529 plans, they are formally known as “Qualified Tuition Programs,” as defined in Section 529 of the Internal Revenue Code, and are administered by state agencies and organizations.
Savings in a 529 plan grow free from federal income tax, and withdrawals remain tax-free when used for qualified higher education expenses. Additionally, many states mirror the federal 529 plan tax advantages by offering state tax-deferred growth and tax-free withdrawals for qualified higher education expenses.
Why State Plans Differ
Each state that offers a 529 plan determines how its plan is structured and which investment options are offered. While many plans allow investors from out of state, there can be significant state tax advantages and other benefits for in-state residents. These can include state tax deductions, matching grants, and scholarship opportunities, protection from creditors and exemption from state financial aid calculations. Click here to Compare 529 Plans by State.
Types of 529 Plans
There are two types of 529 plans:
Prepaid Tuition Plans
There are currently 11 prepaid tuition plans (sometimes called guaranteed savings plans) offered by 10 states and the Private College 529 Plan (PC529). These plans allow participants to pre-purchase future tuition at a predetermined rate today. Typically, an account owner will purchase somewhere between one and four years of tuition for a young child, and when that child reaches college age, the plan pays out based on tuition rates at that time. Investment performance is often based upon tuition inflation. Prepaid plans may be administered by states or by higher education institutions.
College Savings Plans
College savings plans are different in that your account earnings are based upon the market performance of the underlying investments, which typically consist of mutual funds. Savings plans may only be administered by states. Forty-nine states and Washington, D.C. offer a savings plan. Most 529 savings plans offer a variety of age-based investment options where the underlying investments become more conservative as the beneficiary gets closer to college-age. They also offer risk-based investment options where the underlying investments remain in the same fund or combination of funds regardless of the age of the beneficiary. In addition, many savings plans offer an FDIC/NCUA insured, money market or guaranteed option designed to protect an investor’s principal while providing for some investment growth, while others offer investments in certificates of deposit.