529 plan

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans are termed "qualified tuition plans" by the IRS, which authorized the plans in 1996 in Section 529 of the Internal Revenue Code. 529 plans are sponsored by states and private education institutions. There are two types of 529 plans: pre-paid tuition plans, which can be offered by states or private institutions, and college savings plans which can only by sponsored by states. 529 savings plans can be sold directly to investors without sales charges, or can be sold through advisor sold plans with sales charges.

The law is quite liberal in allowing contributions to a child's 529 plan. Relatives, friends, colleagues, acquaintances and even complete strangers can make contributions. The Federal government does, however, require states to impose limits on contributions, based on the expected cost of undergraduate and graduate educations. State contribution limitations on 529 savings plans range from $146,000 to $305,000. The median limit is $235,000. Limits on contributions to 529 prepaid plans range from $50,000 to $100,000.

529 Prepaid Plans
Prepaid tuition plans allow families to purchase the cost of future college tuition at present-day prices. The state guarantees that the value of the investment will meet or exceed annual in-state public college tuition inflation. The price you will pay for such protection will vary, depending on the age of the student (lower for a young child; higher for older children) and, of course, the cost of tuition. There are two types of prepaid tuition plans, a units plan and a contract plan. A units plan allows you to buy units of tuition (for example, a unit could equal one percent of state college tuition). A contract plan lets you purchase contracts for one to five years of tuition. Account holders can usually contribute to either of the two plan types in a lump sum or in installments. . Investors can open a prepaid plan when the plans enter a limited open enrollment period, usually once a year. The prepaid plan will reveal its new tuition pricing with each new enrollment period. Prepaid plans can and do suspend enrollment periods. Timely information on a plan's enrollment period and current pricing are conveniently available on the Saving for College links in the second table below. Example:The Illinois 529 Prepaid Tuition Plan, a contract plan, will provide an example of prepaid tuition plan pricing for the 2008-2009 enrollment period. The plan allows payments in single installments; monthly payments over a five year term; and monthly payments over a ten year term. Plan beneficiaries are divided into three age groups: kindergarten and younger; first grade through eighth grade; and ninth grade and older. The contract pricing illustrated in the table below is for 9 semesters at a university and shows prices for attaining complete tuition payment. The plan also provides other schedules for payments for fewer semesters as well as for community college tuition.

In 2004 individual educational institutions were permitted to begin offering their own prepaid tuition plans. The Independent 529 Plan is a national prepaid tuition plan offered by a group of several hundred private colleges. The list below provides links to state provided 529 prepaid tuition plans, along with the Independent Plan.

Prepaid plans can be costly if you decide to pull out the plan. Such action can result in stiff penalties, including a cancellation cost and/or loss of interest (see sidebar.)

529 College Savings Plans
529 savings plans are state-sponsored investment accounts. 529 portfolios are very similar to mutual funds and are managed by mutual fund companies. Assets inside a 529 savings plan can grow tax-deferred and are distributed tax free when used for "qualified education expenses". Unlike pre-paid tuition plans, the results one receives from a 529 savings plan are dependent on market performance and are not guaranteed.

For a side by side comparison of Prepaid and College Savings plans, please refer to this chart from FINRA.

529 Plan Investment Programs
] 529 Savings Plans may employ three main types of investment programs; age-based portfolios, static fund of funds portfolios, and standalone portfolios. Many states offer multiple 529 savings plans, often providing a direct-sold plan and an advisor (commissioned) sold plan. Many states provide both actively managed and indexed portfolios.


 * Age-Based Portfolios: Age-based portfolios are designed primarily for children beneficiaries. They are broadly diversified fund of funds portfolios that set allocations based upon a child's present age. The fund automatically changes allocations to more conservative postures as the child matures. The portfolios' glide paths normally run from birth to age 17 or 18, the time of expected matriculation. The figure to the right (click image to enlarge) shows the  asset allocation and glide path of one of the Ohio 529 plan's age-based portfolios. The portfolio is largely allocated to equities at early ages, with the equity allocation declining over time, until the portfolio is largely allocated to cash and bonds at age 18. A common feature of many 529 savings plans are multiple risk-based Age-based options, usually including a Conservative, Moderate, and Aggressive portfolio option. The North Carolina age-based plan of Vanguard  Life Strategy portfolios (figure on the left, click to enlarge) is an example of this type of offering. Asset allocations, glide paths, and returns can vary considerably among the eighty-odd 529 plan age-based portfolios.
 * Static Fund of Fund Portfolios: Another common offering in 529 savings plans is the static asset allocation fund of funds portfolio. These multiple fund portfolios maintain a constant asset allocation. These portfolios vary considerably. Some portfolios consist of stock funds, some are balanced across asset classes (stocks, international stocks, and fixed income). Some are exclusively invested in bond and money market funds. These funds allow an investor to choose an asset allocation and select the individual or multiple portfolios which match the desired allocation. The DFA portfolios in the West Virginia 529 Plan (SMART 529) provide a good example, with a wide selection of these type funds.
 * Standalone Portfolios: Some plans offer standalone asset class portfolios (see Virginia 529 Plan for an example), These type funds allow an investor to design and execute a specific asset allocation plan with individual asset class funds. With both static fund of fund portfolios and standalone portfolios the investor must decide if, and when, the allocation needs to become more conservative as the time nears for dispersing plan assets.

Tuition Indexed Programs

 * Collegesure 529 Tuition Indexed Programs
 * CollegeSure CD Product Disclosure

529 Plans Investment Considerations

 * Retirement Savings have priority
 * Bogleheads Investing Philosophy
 * Bogleheads Investment Philosophy
 * 529 Plans Indexed Options
 * In state plan or out or state plan

One can determine the breakeven point where using a lower cost plan option becomes cheaper than a state plan providing tax deductible and/or matched 529 contributions by using the following factors
 * The tax savings amount (Deductible contribution x marginal state tax rate) + match.
 * The cost differential between the plan and the lower cost plan.


 * Dividing (1) by (2) provides the capital accumulation point where the lower cost plan subsequently overtakes the tax benefit.

A number of states now recapture deducted 529 contribution taxes if a plan is transferred to an out of state plan. Refer to this table for a list of these states.

Federal Tax Benefits
Contributions to a 529 plan are not tax deductible on the federal tax return. However, earnings and capital appreciation are tax deferred in a 529 plan, and distributions are tax free for "qualified education expenses". According to the IRS "qualified expenses" are the amounts paid for tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include the reasonable costs of room and board for a designated beneficiary who is at least a half-time student. The cost of room and board qualifies only to the extent that it is not more than the greater of the following two amounts.


 * The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
 * The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Federal Tax Penalties
Withdrawals from a 529 Savings Plan are considered non-qualified withdrawals if they are in excess of qualified education expenses. Non qualified withdrawals are taxed at the account owner's tax rate and subject to a 10% additional tax on the amount included in income. This 10% additional tax does not apply to distributions meeting the following exceptions:


 * Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.
 * Made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.
 * Included in income because the designated beneficiary received:
 * A tax-free scholarship or fellowship,
 * Veterans' educational assistance,
 * Employer-provided educational assistance or
 * Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
 * Made on account of the attendance of the designated beneficiary at a U.S. military academy (such as West Point).
 * Included in income only because the qualified education expenses were taken into account in determining the Hope or lifetime learning credit.

Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment. The additional tax is figured on Part II of Form 5329.

State Tax Benefits
States follow the federal tax system in allowing tax deferral of earnings and gains in a 529 Plan. Every state, with the exception of Alabama, allows tax free withdrawals from 529 plans for qualified education expenses. In addition, many states allow one to deduct or partially deduct 529 plan contributions on the state income tax return. Some states also offer a state match for plan contributions. This State Tax Deductions for 529 Contributions table provides a listing of all state tax deductions for 529 plans. Information is also available in our individual state 529 Plan wiki pages (see navigation box below).

Some states impose a recapture tax on prior tax deductions when a 529 plan is rolled over to another plan.

Estate Benefits
529 Plans confer a potential estate tax benefit to donors. Contributions to a 529 Plan are removed from the donor's estate and are transferred to the estate of the beneficiary. All yearly contributions below the $13,000 per recipient gift tax provision are removed from a donor's estate, and a special tax provision allows donors to donate up to $65,000 to a 529 plan in a single year without incurring gift tax. The donation is, for gift tax purposes, spread over the ensuing five years. The donations are only brought back into the donor's estate if the donor dies or terminates the account within the five year extended period.

529 Plans and Financial Aid
For financial aid purposes, both 529 Savings Plans and 529 Prepaid Tuition Plans are considered parental assets and are thus subject to the maximum 5.64% valuation assessment of parental assets in federal needs analysis. (Student assets are assessed at a flat 20% rate.)

Transferring Beneficial and Owner interests
Members of the beneficiary's family. For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary.


 * Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them.
 * Brother, sister, stepbrother, or stepsister.
 * Father or mother or ancestor of either.
 * Stepfather or stepmother.
 * Son or daughter of a brother or sister.
 * Brother or sister of father or mother.
 * Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
 * The spouse of any individual listed above.
 * First cousin.

Helpful Sites

 * Saving for College
 * Morningstar - 529 Plans
 * College Savings Plan Network
 * College Board
 * FinAid Section 529 Plans
 * Information for Financial Aid Professionals (IFAP) Library
 * Vanguard College Savings Center
 * College Savings Bank

Academic Papers

 * Bogan, Vicki, "Are Higher 529 College Savings Plan Fees Linked to Greater State Tax Incentives?" . Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1146539
 * Bullard, Mercer, "The Visible Hand in Government-Sponsored Financial Services: Why States Should Not be Allowed to Offer 529 Plans" . University of Cincinnati Law Review, Vol. 74, 2006 Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=826105
 * DeGennaro, Ramon P., "Asset Allocation and Section 529 Plans" . International Journal of Business, Vol. 9, No. 2, 2004 Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=423800
 * Kaplan, Richard L., "Back to School: The New Parameters of Funding a Grandchild's College Education" . Journal of Retirement Planning, pp. 25-36, January-February 2008 Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1092230
 * Luna, LeAnn and Alexander, Raquel Meyer, "State-Sponsored College 529 Plans: The Influence of Tax and Non-Tax Factors on Investors' Choice" (January 31, 2005). Available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=657422