What are usually referred to as 529 plans are properly called Qualified Tuition Programs (QTPs). They were first authorized by the Federal Government in 1996 to encourage parents to plan for the college education of the next generation.
The 529 Plan is State-sponsored. It’s intended that the proceeds are used for tuition fees and all the other costs associated with education beyond high school. That would cover issues like accommodation, books and general expenses associated with going to college.
Generally, tax exemptions are generous. Contributions are deductible for Federal Income Tax and some states allow deduction for state tax purposes too. Deposits into these plans are also exempt from the Gift Tax – up to a ceiling of $55,000 for an individual and double that for a married couple. For a donor parent, the limit for tax relief is set at a quarter of a million dollars annually.
Any interest earned in a 529 plan is automatically free of tax, as are withdrawals provided that those withdrawals are used for the intended purpose. If it’s discovered that money has been diverted to non-educational use, a ten per cent surcharge is levied on the tax due.
The Economic Growth and Tax Relief Act of 2001 made 529 plans even more appealing when it came into force at the beginning of 2002. As well as the breaks already available, it allowed for the switching of investment options within a plan once a year; the rollover of one 529 plan into another once a year, and a contribution to a Coverdell Education Savings Accounts (formerly Education IRAs) as well a 529 plan in the same year.
A concession of a less financial nature was also incorporated in that act – it allowed for the transfer of beneficiary to a first cousin as an alternative to a sibling. It was in this act too that the “sunset” for the scheme was set at the year 2010 but all the provisions are, of course, available for amendment as Congress sees fit.
The breaks are available to parents, young people themselves and, quite importantly, Grandparents. In fact, Grandparents get more incentive to contribute than anyone else – any funds they hold are not considered part of their estate and they’re allowed to switch beneficiary from grandchild to grandchild as they choose.
With a 529 Plan, the account is in the student’s name, but whoever sets up the account maintains control of it. If the child doesn’t eventually go to college or if they’re given a tuition package good enough for them not to need their plan, the original donor can change the beneficiary to another member of the original beneficiary’s family.
529 plans come in two formats, College Savings Plans and Prepaid Tuition Plans. All states offer at least one of the options and quite a number offer both. College Savings Plans let parents use their plan funds for college expenses at any college while prepaid tuition plans guarantee current prices. These are restricted to in-state public colleges.
A College Savings Plan will almost certainly offer more options than a Prepaid Tuition Plan. That savings method gives much greater flexibility in college choice, an important advantage considering that a savings plan can start up to 15 years before the college selection process gets underway.
If the idea of prepaid tuition has more appeal, it can still be done through a college savings plan, by using four years of in-state public tuition as the savings goal.
Another advantage of college savings is that, if the child qualifies for need-based aid, the federal formula will ask a much lower contribution from college savings than from a prepaid tuition plan.
A 529 Plan should be seen as an investment in the same way that any other savings plan and, with the myriad of schemes available, it’s vital that great care is taken when setting one up.
It’s almost certainly a good idea to meet with the department in your state that administers the plans – a good number of states have retained investment professionals to advise on and sometimes to operate them.
Otherwise, there are the usual options of brokers and specialists and of course, the banks. Whichever route you chose, careful planning will pay off in the long term.