529 plan
A 529 plan is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary. It is named after section 529 of the Internal Revenue Code. Although states sponsor 529 plans, recordkeeping and administrative services are generally delegated to a mutual fund company.
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. 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. They also offer risk-based asset allocation options where the underlying investments maintain the same equity-to-fixed-income ratio regardless of the age of the beneficiary. Many savings plans also offer a stable value or guaranteed option designed to protect an investor's principal while providing for some investment growth.
With the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), 529 plans gained their current prominence and tax advantages. Prior to EGTRAA, distributions from 529 plans for qualified higher education expenses were taxed at the beneficiary's federal income tax rate. After EGTRAA, distributions from 529 plans for qualified higher education expenses are exempt from federal income tax. The 529 provisions of EGTRAA are set to expire on December 31, 2010. If the provisions expire, tax treatment will revert to pre-EGTRAA.
Advantages
- All money grows federal and state income-tax free
- All distributions for qualified higher education expenses are federal income-tax free (federal tax-free withdrawals expire 12/31/10 unless extended by Congress)
- Many states also exempt withdrawals from state income-tax for qualified higher education expenses
- Money can be used virtually everywhere -- over 8,000 schools in the U.S. and over 800 foreign schools
- Money can be used to pay for tuition, room, board, books, fees, supplies and required equipment
- The beneficiary can be changed at any time
- High maximum contribution limits
- Powerful estate planning advantages -- account owners can contribute up to $60,000 per beneficiary or $120,000 (married filing jointly) immediately as long as they don't make additional contributions until 5 years has passed
The income tax advantages have contributed significantly to their popularity as a college savings tool.