529 Savings Plan
A tax-advantaged savings plan used with the main purpose of paying for a college education.
529 Savings Plan Details
A 529 savings plan is the most common education savings accounts in the U.S. There's no limit to annual contributions, but there is a limit for the total amount you can put away. Depending on the state, that total can range from $235,000-$500,000. More than 30 states provide tax deductions or credits of different amounts for investing in a 529 plan. Contributions earned from investments are not subject to federal tax as long as you use the earnings for "qualified expenses." Qualified expenses include tuition, books, school supplies, and room and board.
Different states offer different variations of the 529 plan. The variation depends on the state and sometimes what school the student is or will attend. Most people don't realize that a client doesn't necessarily need to live or even attend school in the same state where they invest. For example, a person who lives in New York and has a child studying in Chicago can invest in a Missouri 529 plan.
If the child doesn't end up going to college, you can still use the money. It's possible to change the beneficiary of the account from one child to another, or you can withdraw the money with a 10% penalty fee (plus taxes on the returns). Should a child receive a scholarship, the money isn't lost but might go through some taxing at withdrawal. Also, the beneficiary, meaning the child, cannot withdraw anything from the account without the owner's approval, who, in most cases, is the parent.
Example of a 529 Savings Plan
If you open a 529 savings plan, you can contribute as much as you want right away, as long as it's no more than the maximum limit. In a hypothetical situation, a parent contributes over $150,000, and because they invested the money in mutual funds that did well, it turns into $170,000.
The benefactor can spend this money once they enter college. Most times, parents/benefactors use the money to pay tuition and all school costs. You can buy all the supplies the student needs from that money, and if the benefactor decides to dorm, the money covers room and board. How you divide the money is ultimately up to you.
Types of 529 Savings Plans
Each state has different regulations for its 529 plans, but there are two main types with significant differences: a savings plan and a prepaid tuition plan.
A savings plan is by far the one people choose most of the time. The money you put into the account is usually invested in mutual funds. Depending on the funds' performance, the money can grow, or in the worst-case scenario, shrink. States also offer target-date funds that adjust their holdings as the beneficiary gets closer to college.
A prepaid tuition plan is only available in a limited number of states and is offered mainly to those involved with higher educational institutions. Essentially, it allows the investor to prepay parts or all of an in-state college education. The investor can also use the money for private colleges, but that is a separate plan with different details.