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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. The detailed behaviour of 529 plans are determined by state legislation, and while most plans allow investors from out of state, there can be significant state tax advantages for investors to invest in 529 plans within their state of residence.

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. 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, while others offer investments in certificates of deposit.

Prepaid plans may be sponsored by states or higher education institutions. Savings plans may only be sponsored by states. Although states sponsor savings plans, recordkeeping and administrative services for many such savings plans are delegated to a mutual fund company or other financial services company.

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 plan provisions of EGTRAA were made permanent by the Pension Protection Act of 2006. Originally the benefits were set to expire on December 31, 2010.

Advantages

  • All money grows federal and state income-tax free
  • The account holder retains control of the assets within the program regardless of beneficiary's age
  • The beneficiary can be changed at any time
  • Many states 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, fees, room, board, books, supplies and required equipment
  • High maximum contribution limits
  • Account owners can contribute up to $60,000 per beneficiary or $120,000 if married filing jointly immediately (as long as they don't make additional contributions until 5 years have passed), if they wish not to pay gift tax on their contributions. Should a donor die within those 5 years, a pro-rata amount of the gift will revert back to their estate and will have gift tax due on it
  • Assets within 529 plans are protected from bankruptcy

The income tax advantages have contributed significantly to their popularity as a college savings tool.

See also

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