By Abigail Warren, Fall 2017 IAC Student Intern
529 college savings plans are qualified tuition plans. FINRA describes these plans as tax- deferred where withdrawals are tax-free as long as you use the money for “qualified education expenses”. Qualified education expenses are much broader under 529 college savings plans than prepaid tuition plans, and include expenses such as tuition, books, supplies, room and board, computers, printers, and software. Adults and children, alike, can benefit from a 529 college savings plan, and you can use these plans for college or graduate school. You can also transfer money tax free to a child, a beneficiary’s sibling, or a spouse.
Since states sponsor these plans, they vary from state to state, but, unlike prepaid plans, most 529 college savings plans do not have a residency requirement. Comparing plans will help you decide which plan is best for you. According to the SEC, some states offer tax advantages to residents that participate in a local plan, such as deductions or personal income tax credits for contributions made to in-state programs, while other states offer tax incentives to those who contribute to any 529 plan. Contact the program in your state to get the tax rules for investing in 529 plans. Unlike prepaid plans, states do not guarantee or insure 529 college savings plans, and these plans are subject to market risk.
Each plan sets its own contribution limit, with the maximum often exceeding $250,000 and the minimum as little as a $250 initial contribution and $50 a month subsequent investments. If you estimate education costs to exceed the maximum allowable contribution, you can open a second plan in another state as long as the amount does not exceed the amount of qualified education expenses for that child/beneficiary.
529 College Savings Plans offer limited investment options. These options include stock mutual funds, money market funds, age-based portfolios that pair younger beneficiary with higher-risk investments that automatically shift to more conservation investments as the child gets closer to college-aged.
When opening a 529 College Savings Plan, you can opt for a direct-sold or a broker-sold plan.
Plans you buy directly from the broker-dealer who administers the plan on behalf of the state.
Plans you buy through an outside brokerage firm, investment advisor, or bank. These plans offer three classes of shares – Class A, Class B, and Class C – with different fees and expenses tied to each class.
Finally, 529 college plans have restrictions and penalties. These restrictions include limited investment options with limits on how often you can switch options and contributions that are available only for qualified education expenses. If you withdraw the money for any other purpose, you are subject to income tax and a federal tax penalty. Another consideration is that 529 savings will count as parental assets when determining financial aid eligibility.
FINRA advises you to get schooled by following 8 lessons before you invest in a 529 college savings. FINRA also offers several tips on withdrawing money from your 529 Plan, such as making sure withdrawals and matching qualified education expenses occur in the same tax year and saving the receipts for education expenses.
Look for information on fees in Part IV – 529 Plans and Fees