529 plans are tax-advantaged savings programs that allow you to save for your child’s college funding.1 They are generally sponsored by individual states, but in some cases may also be sponsored by qualified educational institutions. They are administered by investment companies, which also oversee the underlying investments.
There are two types of 529 plans:
- Prepaid tuition plans let participants pay for future tuition at today's rates, essentially taking inflation out of the equation. These plans are generally available only to residents of the sponsoring state and may be intended for in-state tuition (participants may be able to use the money at out-of-state schools, but only a reduced percentage of the balance in some cases).
- College savings plans let participants invest their contributions in portfolios of mutual funds or similar managed financial instruments. Money in a college savings plan can be used for qualified undergraduate and graduate expenses at any accredited college or university. Many of these plans are national plans: No matter which state or school sponsors them, residents of any state can participate. With some 529 college savings plans, contributions are allocated to a particular portfolio based on the child's age. As the child nears college age, the money shifts to different portfolios with appropriate risk and return potential. Other 529 plans offer greater investment flexibility, letting the account holder choose from a range of securities.
The potential advantages of 529 plans include:
- Earnings in a 529 plan accumulate free from taxes, and qualified withdrawals are federally tax free. Withdrawals may be exempt from state taxes as well (tax rules vary from state to state). Nonqualified withdrawals from a 529 plan may be subject to income taxes and a 10% additional federal tax.
- Contributions to a 529 plan are considered a gift for federal tax purposes. Tax rules currently let you give up to $14,000 to as many individuals as you choose, free from federal gift taxes. Gifting schedules can also be accelerated through a lump-sum contribution of $70,000 to a 529 plan in the first year of a five-year period.
- They have generous contribution rules. Lifetime contribution limits on 529 plans vary from state to state, but often exceed $200,000 per beneficiary, including earnings. In addition, there usually are no income restrictions on contributors to a 529 plan.
1Investing in 529 plans involves risk, including loss of principal. Before you invest in a 529 plan, request the plan’s official statement and read it carefully. The official statement contains more complete information, including investment objectives, charges, expenses, and the risks of investing in a 529 plan, which you should carefully consider before investing. You should also consider whether your home state or your beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s 529 plan. Section 529 plans are not guaranteed by any state or federal agency. By investing in a 529 plan outside of the state in which you pay taxes, you may lose the tax benefits offered by that state's plan. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary.