What is a 529 plan?

A 529 plan is an investment vehicle with tax advantages in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary.

While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, protection from creditors, and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence.

Types of 529 College Plans

There are two types of 529 plans: prepaid and savings.

  • Prepaid plans allow one to purchase tuition credits, at today’s rates, to be used in the future. Therefore, performance is based upon tuition inflation. Savings plans are different in that all growth is based upon market performance of the underlying investments, which typically consist of mutual funds. Most 529 savings plans offer a variety of age-based asset allocation options where the underlying investments become more conservative as the beneficiary gets closer to college age. Prepaid plans may be administered by states or higher education institutions.
  • Savings plans may only be administered by states. Although states administer savings plans, record-keeping and administrative services for many savings plans are usually delegated to a mutual fund company or other financial services company.

 

Money from a 529 plan can be used for tuition, fees, books, supplies and equipment required for study at any accredited college, university or vocational school in the United States and at some foreign universities.

The money can also be used for room and board, as long as the fund beneficiary is at least a half-time student. Off-campus housing costs are covered up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes.

Qualified education expenses do not include student loans and student loan interest.

A distribution from a 529 plan that is not used for the above qualified educational expenses is subject to income tax and an additional 10% early-distribution penalty unless one of the following conditions is satisfied:

  • The designated beneficiary dies, and the distribution goes to another beneficiary or to the estate of the designated beneficiary.
  • The designated beneficiary becomes disabled. A person is considered disabled if there is proof that he or she cannot do any substantial gainful activity because of a physical or mental condition. A physician must determine that the individual’s condition can be expected to result in death or continue indefinitely.
  • The designated beneficiary receives any of the following:
    • a qualified scholarship exclude-able from gross income
    • veterans’ educational assistance
    • employer-provided educational assistance
    • any other nontaxable payments (other than gifts, bequests or inheritances) received for education expense