What is a 529 Plan?

The plan is named after section 529 in the Internal Revenue Code and is designed as a method to save money for higher education for your child or yourself.

529 plans offer two major incentives:

  1. The money you put aside, and the interest you earn, in these plans are tax free.
  2. When you use money in your plan for college tuition, room and board, fees, books, supplies, and equipment, these funds are not subject to federal or state income tax.

529 plans are much like a company's 401K plan. You simply choose from a menu with a pre-set number of investment options. You do not have the ability to purchase only stock shares, such as Apple or Caterpillar stock.

The plans are considered "state sponsored," which means that each state has to approve a plan provider before that provider can offer 529 plans to the public. Some states offer only one plan; other states offer multiple plans. You do not, however, have to participate in the plan that your state offers. You can cross borders, for example, a California resident can purchase a plan sponsored in Nevada. Before you choose a plan from another state, though, you may want to check the state tax advantages (if any) of contributing to a plan in your state of residency.

Some key elements of 529 plans:

  • Eligibility
    Anyone can contribute to these plans. There are no income limitations.
  • Control
    Since you are the plan owner, you maintain control over the account (not your child, no matter how old the child is).
  • Contribution Limit
    The maximum total contribution limit varies depending on who the plan sponsor is, and in some cases, you could contribute as much as $275,000 into the plan over a number of years.
  • Income Tax Advantages Growth in the account is not ever taxed—as long as the distributions are used for the purpose of higher education there is no age restriction—the funds could be used for a four-year-old prodigy or a late-bloomer taking college classes.
  • Control of Investments
    You must pick from a menu of investments offered by the plan provider.
  • Distribution Use
    You can use the money to fund any post-secondary school education for your child or yourself.
  • Financial Aid
    Since you, not your child, are considered to be the owner of the account, the amount accumulated in the 529 plan is not considered among the child's assets when determining eligibility for financial aid.
  • Gifting/ Estate Tax Advantages
    Currently, you can put as much as $13,000 per year into your 529 plan—or up to a maximum of $65,000 and spread it over any five-year period. You or anyone else who makes these contributions into the 529 account may also benefit from state tax relief.

Some commonly asked questions regarding 529 plans:

  • What if my child does not go to college?
    In that case you can change the beneficiary to another family member or yourself.
  • Can you change the beneficiary?
    Yes, as frequently as you'd like.
  • Can you change plans from one provider to another?
    Typically, yes, but you can only do that once a year.
  • What if the funds are not used for higher education?
    It's still your money. If you choose to use the funds for a purpose other than higher education, you'll have to pay a 10% penalty on the growth in the account, when you withdraw the funds.
  • Where can I obtain more plan-specific information?
    Each plan's prospectus provides a wealth of important information regarding fees, expense ratios, and performance.
  • How do I determine how much to contribute for my child?
    There are many online resources available including calculators to help you determine the right amount for your child's needs and for your economic situation.
  • How do I choose a plan?
    See How to Choose a Section 529 Plan for more information and insights into selecting a plan.

Fin Tip

If you're finding it difficult to eke out those extra dollars to save for your child's education, and you've already solicited the grandparents, try this. At your child's next birthday party, instead of having people provide gifts, consider asking people to contribute cash for your child's 529 plan account. Or you can simply return some of the gifts for cash and put those dollars into the plan. A little each birthday or other gift-giving occasion adds up.