The 529 College Savings Plan
Simply stated, a
529 plan is a qualified tuition program that encourages families to save for one of their most important financial obligations - their children's education
. Although officially known as "
qualified tuition plans," the 529 plan, named after Section 529 of the Internal Revenue Code that governs them, are sponsored by states, state agencies, or educational institutions. They are most often sponsored by individual states and managed by a mutual fund or other financial services company. Earnings on 529 investments accumulate tax-free, and distributions are tax-exempt as long as they are applied toward eligible education expenses such as tuition and room and board.
With most 529 plans, an account is opened on behalf of a designated beneficiary, usually a child or grandchild. The contributions are placed in a fund established by the individual state and then directed into an investment portfolio designed and managed exclusively for the program. Earnings in the account grow federal, and in most cases, state tax-free, until the time the beneficiary is ready to go to college. The funds are available to be used to pay for qualified higher education expenses at any eligible school - including two and four-year colleges, technical, vocational, and graduate schools. However, if money is withdrawn from a 529 plan and is not used for eligible college expense, there generally will be an income tax obligation and an additional 10% federal tax penalty on earnings. Some states also offer an upfront tax deduction for contributions. Certain states require that the contribution be made to that particular state's plan for it to be deductible, but not all states have that requirement. Individual states may treat withdrawal transactions differently and may have state tax consequences for residents of certain states so it is always important to discuss all potential benefits and obligations with a tax professional.
Undoubtedly, the main benefit of the 529 plan is that the principal grows tax-deferred and distributions for the beneficiary's college costs are exempt from tax. Another important aspect of the plan is the donor maintains control of the account in almost all cases. This eliminates the potential for the beneficiary to utilize funds for purposes not associated with higher learning as intended. Lastly, the dollar limits for contributing to a beneficiary are substantial, in excess of $300,000 in most states and because there are generally no income limits or age restrictions tied to eligibility, essentially everyone can take advantage of the attractive 529 savings plan.