Comprehensive Guide to 529 College Savings Plans


A 529 college savings plan helps students and families save money for college. For many families, a 529 plan can help maximize college savings while also providing tax benefits. In 2015, Americans saved a total of $258 billion through 529 plans, and this number continues to increase.

But 529 savings plans can be difficult to understand. With so many types of 529 plans -- every state offers at least one 529 plan -- choosing a 529 plan can feel overwhelming.

This article covers the different types of college savings plans, common questions and misconceptions about 529 plans, and how to maximize savings with a 529 plan.

What Is a 529 Plan?

A 529 college savings plan offers tax advantages to save for future educational expenses. Parents can open 529 plans for their children, and people of all ages can open a 529 for their own educational expenses.

Investing college savings in a 529 plan brings several benefits. In some states, account holders can deduct contributions on their state income taxes. Beneficiaries can also withdraw the money to pay for college without paying federal income taxes. The money in a 529 savings plan can pay for expenses at hundreds of accredited colleges and universities, including trade and vocational schools.

Also known as "qualified tuition plans," 529 plans come in several forms, including savings-based 529 plans and prepaid tuition 529 plans. In a savings-based, or traditional, plan, account holders invest their college savings in a tax-advantaged account. The prepaid tuition option lets savers buy tuition at today's prices to attend college in the future.

However, 529 college savings plans come with several rules and regulations that potential savers should understand before opening an account. For example, beneficiaries must use the money on qualified educational expenses or pay a penalty and taxes. Different plans also impose varying fee structures and restrictions.

529 Plan Figures and Statistics

College costs continue to rise. In 2018, in-state public universities charged over $9,000 per year in tuition and fees, according to the National Center for Education Statistics. Out-of-state students paid over $26,000 per year, while private schools charged nearly $32,000 per year in tuition and fees. On top of tuition, students often pay for housing, books, and other expenses.

As a result, many students must take out student loans to cover the cost of college.

In 2015, Americans saved $258 billion on 529 plans. While this amount is a fraction of the $1.2 trillion in student loan debt, it is a growing asset to help future generations limit their school debt.

Today's college students increasingly rely on 529 plans to pay for their education. Between 2010-2013, the amount of student aid from 529 plans grew by more than 45%.

Increase in Financing Education
Academic Year
Grants
Loans
529 Plans
2010-2011 $118 billion $122 billion $11 billion
2011-2012 $116 billion $119 billion $13 billion
2012-2013 $118 billion $115 billion $14 billion
2013-2014 $123 billion $123 billion $16 billion

Source: FederalReserve.gov

Types of 529 Plans and Key Definitions

Savings-based vs. prepaid tuition. State plans vs. private plans. Age-based investments vs. actively managed plans. It is easy to feel overwhelmed by the many types of 529 college savings plans.

How can you find the best plan for your unique circumstances? You can start by understanding the different types of plans and who benefits from each type. This section introduces the most common 529 plans, including traditional and prepaid tuition plans, and the key definitions to make an informed decision.

Savings-Based or Traditional 529

In 2015, savings-based or traditional 529 plans reported about 10 times as many assets as prepaid tuition plans, making them the most common 529 plan. These savings plans let people open an account and invest in mutual funds or other portfolios.

Traditional 529 plans offer the greatest flexibility. Students can use the money for any qualified higher education expense at any school, including tuition, fees, and living expenses. Beneficiaries can also use the money to pay for a public or private K-12 school. Individuals can consider options like direct-sold and advisor-sold traditional 529 plans.

State-Sponsored Prepaid 529 Plans

In 18 states, individuals can open a prepaid 529 plan. In these plans, investors purchase tuition credits based on current tuition rates that cover the cost of future educational expenses. For example, Florida residents can pay for a year's worth of tuition at today's rate to cover one year of college in 10 or 15 years, regardless of tuition increases.

However, prepaid plans come with some restrictions. In general, the person opening the account or the beneficiary must reside in the state offering the plan. Beneficiaries typically attend an in-state public school, though prepaid plans can also cover tuition costs at other institutions.

Prepaid Private College 529 Plan

Prepaid private college 529 plans function similarly to state-sponsored plans. However, unlike state-sponsored prepaid tuition plans, a prepaid private college 529 plan does not carry residency requirements.

Instead, individuals pay for private college tuition at today's rates. Beneficiaries can use the prepaid credits to attend any of the 300 private colleges that participate in the private plan.

If the beneficiary chooses not to attend one of the participating schools, the account holder can name a new beneficiary, roll the money into another 529 plan, or request a refund -- subject to taxes and penalties.

Tax Advantages

Many states offer tax advantages for 529 college savings plans. For example, account holders can receive a state tax deduction for contributions to the plan or tax-free withdrawals. These benefits can potentially save account holders thousands of dollars. In states that let account holders defer taxes on earnings, for instance, the account may grow faster than a taxable investment.

However, most states only offer these tax advantages to residents who open an account in the state. Individuals who live in a state that does not offer tax advantages may want to explore opening a 529 plan in a different state.

Age-Based Investment Approaches

When it comes to investment approaches, 529 plans offer a variety of options. For example, savers can invest in a mutual fund or a principle-protected portfolio. Many choose an age-based portfolio that automatically rebalances the investment as the beneficiary ages.

An age-based investment approach, sometimes called a target-date approach, pursues an aggressive strategy when beneficiaries have many years to see their account grow. The portfolio gradually moves to more conservative investments in the final years before the beneficiary applies to college.

While this approach can help savers maximize their investment, it may not make sense for people planning to use the 529 to pay for K-12 education or those attending college within the next few years.

Actively Managed 529 Plans

Unlike an age-based investment approach, which automatically adjusts the portfolio, a money manager oversees an actively managed 529 plan. While most state-based 529 plans use passive index funds, advisor-sold 529 plans offer more hands-on management.

However, these plans typically charge higher fees than direct-sold plans managed by a financial services firm. In an actively managed plan, account holders may need to pay broker fees in addition to account maintenance or program management fees. As with any 529 plan, individuals must carefully research any fees before signing up for a college savings plan.


Traditional 529 Plan Considerations

Is a traditional 529 college savings plan the best option for your situation? This section highlights some common considerations for people opening a traditional 529 plan.

How does a traditional 529 plan affect state taxes?

Some states offer tax advantages to residents who open 529 accounts in the state. These can include state tax deductions for contributions. In most states, beneficiaries do not need to pay state income tax on withdrawals used for qualifying educational expenses.

How does a traditional 529 plan affect federal taxes?

Although savers cannot deduct their 529 contributions on their federal income taxes, the money grows tax-free, and withdrawals remain exempt from federal income taxes when used for qualifying educational expenses.

What are the restrictions of a traditional 529 plan?

Traditional 529 plans impose few restrictions. Some states limit lump sum contributions or place a maximum limit of $300,000 per 529 account. However, qualified distribution rules limit what beneficiaries can do with the money. In general, people can use 529 accounts to pay for tuition, fees, room and board, textbooks, and technology related to education. Withdrawals spent on non-qualified expenses come with a penalty and income taxes.

What are the fees of a traditional 529 plan? Is there a certain amount threshold?

The fees for a traditional 529 plan vary depending on the plan. Many plans charge a fee based on the size of the account along with an annual maintenance fee. Actively managed fees may also carry broker fees.

What are the steps to getting a traditional 529 plan started?

After researching plan options, people can visit their chosen plan's website to open an account and start saving.

Prepaid 529 Plan Considerations

A prepaid 529 plan lets savers pay today's tuition rates for future college students. Before investing in a prepaid 529, consider the following factors:

How does a prepaid 529 plan affect state taxes?

Only certain states offer prepaid 529 plans. Many of those states offer tax benefits like tax deductions for contributions. However, several states with prepaid 529 plans do not have state income tax.

How does a prepaid 529 plan affect federal taxes?

Like a traditional 529 plan, a prepaid plan lets savers benefit from tax-free growth in their investment. Beneficiaries also do not pay federal taxes on the credits they purchase with the 529 plan.

What are the restrictions of a prepaid 529 plan?

Prepaid 529 plans typically cover in-state educational expenses. However, beneficiaries may be able to use the funds to attend other schools. In some cases, beneficiaries may receive less if they attend an out-of-state school. The federal government also does not guarantee money invested in a prepaid 529 plan, and some states also provide no guarantee.

What are the fees of a prepaid 529 plan? Is there a certain amount threshold?

Prepaid 529 plans tend to come with flat fees for opening an account or cancelling the account. Some prepaid tuition plans set an age restriction on the beneficiary.

What are the steps to getting a prepaid 529 plan started?

After researching prepaid 529 plans, savers can visit the website for their state's 529 plan and sign up online. However, some states only accept applications during an open enrollment period. States may waive the sign-up fee for online applicants.

Common 529 Plan Misconceptions

Misconceptions can stop people from taking advantage of the tax and savings benefits of a 529 plan. This section addresses some of the most common misconceptions about 529 plans.

Do students with a 529 plan need to attend an in-state school?

No, students can use the 529 funds to pay for any eligible educational expense. Even prepaid tuition plans offer the option to roll over the funds into a regular 529 account.

Does having a 529 plan hurt your chances of getting financial aid?

A 529 plan rarely impacts eligibility for financial aid. In most cases, the plan remains a parental asset, meaning the amount can impact the expected family contribution. But in most cases, a 529 plan will not limit financial aid opportunities.

Do you lose the money if the student decides not to attend college?

No, people with a 529 plan can spend the money in several ways. For example, you can change the beneficiary to someone planning to attend college or spend the money on vocational training. You can also request a refund, although this may result in penalties and tax implications.

Can people only open a 529 plan in their home state?

No, you can open a 529 plan in any state. However, some states offer tax benefits to residents who open a plan, so before picking a state, research any benefits from a home-state plan.

Do you need to have a high income in order to contribute to a 529 plan?

No, a 529 plan can help people of any income level save for college. There are no income limits or minimums to open a 529 plan.

Maximizing Your 529 Plan

Opening an account and investing money early is the best way to maximize a 529 college savings plan. Compound interest helps accounts grow year after year, meaning a greater payoff by the time students are ready for college. But people can also maximize their investment by researching employer matching plans, state benefits, and 529 gifting policies.

Some employers agree to match 529 deposits, much like the employer match for retirement funds. This can double every deposit into a 529 account. Similarly, some states offer 529 benefits that can include matching funds. The CHET Baby Scholars program in Connecticut matches up to $250 per child, for example.

Finally, gifting can help maximize 529 funds. Multiple people can contribute to a 529 plan, including grandparents, friends, and other family members. Most 529 plans let anyone contribute to an established account, and several services also simplify the gift-giving process.