What is a 529?
529 Plans, also known as Qualified Tuition Programs, are tax-advantaged college savings plans, designed to encourage saving for the future higher educations costs of a designated beneficiary, such as one’s grandchild or child.
The plan’s name, “529,” derives from Section 529 of the Internal Revenue Code, which created these kinds of saving plans in 1996. 529 plans are operated by a state or state agencies, and the details of 529 plans differ from state to state. Every state offers a 529 plan, and depending on your preferences and interests, you may want to invest in a 529 plan of a different state, for example, a California resident can invest in a Vermont plan. With the money saved from that plan, you can send your beneficiary to most colleges.
There are some limitations to which institutions are eligible and covered by 529 plans. Most two- and four-year colleges and universities, U.S. vocational-technical schools, and certain eligible foreign institutions will be covered under the 529 plan. Savings within 529 plans can be used for tuition, books, and other education-related costs. There are two different types of 529 plans, each with their own unique advantages.
Prepaid Tuition Plans
Two states offer just prepaid tuition plans, and seventeen states offer both prepaid tuition plans and college savings plans. This type of plan allows the person paying into the plan to lock in future tuition rates at in-state public colleges at current prices, and are typically guaranteed by the state.
Prepaid tuition plans are a great value, because regardless of whether inflation or tuition rates increase with time, prepaid tuition plans will always be worth the same amount of education. For example, if a someone purchases shares worth a year of tuition at a state college, the shares purchased will always be worth a year’s tuition, even a decade later when tuition rates may have tripled. Essentially, you’re spending less money to finance the higher education expenses of your beneficiary ahead of time, whereas others who wait until the time comes will pay much more for the same value.
So how does it work? The tuition guarantee is based on an enrollment-weighted average of in-state public college tuition rates. Some prepaid tuition plans have separate plans for two and four year colleges, and for housing expenses. If the beneficiary chooses to attend an in-state public college, the tuition and fees are covered by the plan. However, if the beneficiary chooses to attend a private or out-of-state college, the plan will typically pay the average of in-state public college tuition and the family will be responsible for paying the difference.
Beginning 2004, certain individual education institutions have offered their prepaid tuition plans, such as The Independent 529 Plan, offered by several hundred private college institutions. Most prepaid tuition plans mandate that either the account or the beneficiary be a state resident of the state whose plan they have chosen. Anyone can contribute to a prepaid tuition plan, from grandparents to family friends.
Setting money aside for a loved one’s future tuition expenses through a prepaid tuition plan is a great option because the plans are exempt from federal income tax, and often, state and local income taxes as well. Certain states offer either a full or partial tax deduction for contributions to the state’s plan as well.
If the beneficiary dies or chooses not to go to college, the plans can be transferred to a different member of the family. Regardless of the beneficiary’s actions, the money saved in the plan is controlled by the owner of the account, not the child.
Effective July 1, 2006 prepaid tuition plans were given the same financial aid impact as section 529 college savings plans, meaning that the plan is treated as an asset, with asset valuation equal to the refund value of the plan. Prior to the Higher Education Reconciliation Act of 2005, prepaid tuition plans were treated as a resource, which meant that a beneficiary’s need-based financial aid potential was much lower as a result. (Continued on page 2)
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