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Savings: 529 Plans, Tuition Prepayment, etc

While the traditional "college fund" usually consists of a standard savings plan, there are better alternatives.

529 plans are basically education savings programs that are operated by a state or educational institution that are designed to help families save for college.

The key advantage of any 529 plan is that the money there grows tax free. You typically don’t pay any federal income tax on the earnings – capital gains, dividends and any other growth is all yours. This benefit comes with a restriction, though. The funds can only be withdrawn for qualified educational expenses. You can’t use the 529 money to buy a car, go on a vacation, or for other non-education costs.

529s fall into two categories. One is a prepaid plan and the other is a savings plan, although some have elements of both. You need to do your homework before you select one as tax advantages, investment options, restrictions, and fees can vary.

At a glance, here are the basics of each plan**.

Prepaid Tuition Plans

  • Tuition prices at the state’s public schools are locked in.
  • Only tuition and mandatory fees are covered with some states, allowing some leniency for other qualified expenses.
  • Lump sum and installment payments are set based on age of beneficiary and number of years of tuition purchased.
  • Many plans backed by state.
  • Most plans have age/grade limit for beneficiary.
  • Most plans require either owner or beneficiary of the plan to be a state resident.
  • Most plans have a limited enrollment period.

 

College Savings Plans

  • College costs are not locked in.
  • Covers all "qualified higher education expenses," including:

1. Tuition

2. Room & board

3. Mandatory fees

4. Books and computers

  • Many plans have contribution limits over $200,000.
  • Not guaranteed by state. The investment may make no profit or even decline in value.
  • No age limit.
  • No residency requirement.*

 

* Each state runs its own 529 plan. You can put money into any fund in any state, but generally your earnings will only be exempt from state income taxes if you hold your plan in the state where you reside.

** Please consult with your financial advisor or tax professional to decide which option is best for you.