A Guide To Understanding 529 College Savings Plans.
Article By : Patrick Mansfield | U.S. Consumer Finance
Named after Section 529 of the Internal Revenue Service code of 1996, a 529 plan offers benefits for those looking to save money for college. In this article, we are going to look at the types of 529 plans available, tax effects of 529 plans, and fees associated with creating one of these accounts.
What Types of 529 Plans Exist?
There are two fundamental types of 529 Plans, the traditional 529 College Savings Plan and the Prepaid Tuition Plan.
The traditional 529 Savings plan allows an account owner to invest post-tax dollars into various mutual funds and money market funds on behalf of a beneficiary who plans to go to college at a later date. Typically, the beneficiary will be the account owner's child (or children), but an account owner can open a 529 Savings Account to put aside money for their education as well.
The great thing about funds invested in a 529 account is that they are allowed to grow tax-deferred until the time comes to pay for school expenses, and once that time is reached withdrawals are federally tax-free and tax-free in most states as long as the money is used for education-related expenses.
Furthermore, since "education-related expenses" is a fairly broad term, families will often find that they can apply the funds from this type of account to a wide variety of necessary expenses as long as they can be attributed to educational purposes or needs in some way.
On the other hand, the Prepaid Tuition Plan allows an account holder to purchase tuition credits at qualified public and private schools using today's dollars to save on anticipated future costs that could be higher as inflation eats away at the purchasing power of the dollar.
While these can be great investments at times, Prepaid Tuition Plans are more limited in what the funds can be applied to. Whereas the 529 Plan allows a student to use the money for all education-related expenses, Prepaid Tuition plans explicitly cover tuition and mandatory fees alone. Furthermore, there is a limited enrollment period each year for these types of plans.
Tax Effects of College Savings Plans
As we already mentioned above, contributions to both plan types are made using post-tax dollars. Unfortunately, neither plan allows a federal tax deduction for contributions. However, some states do allow a portion of contributions to be deducted for the tax year that they were made during.
Even though there is no federal deduction available, the fact that the funds are available to grow tax-free and be withdrawn tax-free make this a suitable investment choice for some who are looking to go to school later in life.
Fees Associated with 529 Plans
Prepaid Tuition Plans have straightforward fee structures. Typically, the plan sponsor (usually a college or a broker working on behalf of the college) will charge an enrollment fee for opening the account and then will pass on whatever administrative costs are involved to the account holder.
529 Savings Plans, on the other hand, tend to be a little more expensive. The broker that recommends the plan will often charge a fee called a load fee, the financial firm that manages the assets in the account may charge an annual management fee, and the state sponsor of the plan may have their fees as well.
It is possible to avoid some of these fees by purchasing a Direct-Sold College Savings Plan from the state sponsor because the sponsor will not charge the broker load fees and other administrative fees associated with selling you on the product. To learn more about these sorts of options, you will need to contact the state sponsor responsible for the plan.