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529 College Savings Plans

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Among the many ways to save for college, 529 college savings plans are still one of the most popular options. How does a 529 plan work? Here we explain the types of 529 plans, their rules of investment, and their impact on your financial aid.

What is A 529 College Savings Plan?

529 college savings plans are tax-advantaged investment accounts designed to help families save for college and other post-secondary education as well as K-12 education. These plans can be used to pay for tuition, fees, books and other education expenses at four-year colleges, two-year associate degree programs, trade schools, and vocational schools, as well as public, private, religious elementary, and secondary schools. While plans vary by state, they generally have high contribution limits, flexible investment options, and provide tax advantages. According to the College Savings Plans Network, at the end of 2019 there were over 14 million 529 accounts nationwide with assets totaling $371.5 billion.

The Two Types of 529 Plans

529 College Savings Plans. 529 savings plans generally offer a mix of investment options in mutual fund and exchange traded fund (ETF) portfolios. They may also include bonds, stocks, (neither of which are protected by the federal or state governments) and FDIC-protected money markets (which have no risk of principal). These options are organized into “static” fund portfolios, or age-based portfolios. Age-based portfolios gradually shift to more conservative options with time, while “static” portfolios maintain a fixed allocation strategy.

Each state, plus the District of Columbia, administers its own 529 college savings plan. Most state plans are open to non-residents which means you don’t have to choose the plan sponsored by the state you live in, or the state in which you think your child will attend college. If you live in California, for example, you could enroll in Nevada’s plan, and then eventually use the money to send your child to school in New York.

529 Prepaid Tuition Plans. 529 prepaid tuition plans allow parents, grandparents, other relatives, friends, and others to prepay tuition at today’s tuition rates at eligible public and private colleges. There are a limited number of states that offer such plans and some are no longer open for enrollment. ( provides a state-wide list of participating private colleges). Also, unlike 529 college savings plans, prepaid tuition plans generally have a state residency requirement and some cover only tuition costs at in-state public colleges.

How to Choose a 529 Plan

While choosing a plan may vary based on a family’s needs, some factors to consider include:

  • The annual return on investment for the plan.
  • Whether and what fees are charged by the plan.
  • Whether the plan is direct-sold or advisor-sold (direct-sold plans tend to charge lower fees than advisor-sold plan).
  • Whether the state in which the plan is offered provides any state income advantages for contributions.
  • Type of investment options offered.
  • Minimum contributions.

Benefits of 529 Plans

Tax advantages. Earnings in a 529 plan are federally tax-deferred, and withdrawals for eligible college expenses are tax-free. In addition to federal tax benefits, many states offer state income tax deductions or credits for contributions to a 529 plan.

High contribution limits. 529 plans do not have annual federal contribution limits. However, contributions to a 529 plan are considered completed gifts for federal tax purposes. While gifts are generally subject to a federal gift tax, a gift up to $15,000 per donor per beneficiary qualifies in 2020 for the annual gift tax exclusion and is not subject to the federal gift tax.

There is also an option to make a larger tax-free 529 plan contribution, if the contribution is treated as if it were spread evenly over a five-year period. For example, a $75,000 lump sum contribution to a 529 plan can be applied as though it were $15,000 per year, as long as no other gifts are made to the same beneficiary over the next five years. Per IRS rules, a 529 plan must provide “adequate safeguards” to prevent contributions beyond what is needed to pay for the beneficiary’s future education costs and therefore each state has a maximum aggregate contribution limit per beneficiary ranging from $300,000 to in excess of $500,000.

No residency requirement. Most state-sponsored 529 college savings plans are open to residents of all states, although the state tax benefits may only be available to residents of the sponsoring state.

Beneficiary change. 529 plan account owners may change the beneficiary to a qualifying family member of the current beneficiary at any time without tax consequences, such as if the original beneficiary decides not to go to college or has leftover funds in the plan account after graduation. 529 plan account owners may also change their investment options when the beneficiary is changed.

How a 529 Plan Works - Rules for Using and Investing

Using funds for qualified education expenses. Withdrawals from a 529 account to pay for qualified expenses for the beneficiary at an eligible educational institution are tax and penalty-free. Qualified expenses include tuition, fees, certain room and board expenses, books, supplies, and equipment required for enrollment or attendance. Qualified expenses also include K-12 tuition up to $10,000 per year per beneficiary.

Investment changes. IRS regulations only allow account owners to exchange money from their current 529 investment options to a different option twice per calendar year, although automatic changes within age-based portfolios are not subject to this limit. Changes to investment options for future contributions can be made at any time.

Transfers from other 529 college savings accounts. 529 plan account owners may transfer money from one 529 to another, for the same beneficiary, once every 12 months, and tax-free.

Effects of 529 Plans on Your Financial Aid

Impact of 529 plan on financial aid eligibility.  A 529 plan can affect financial aid eligibility, but the impact depends on the account owner. If a custodial parent or the student owns the account, a maximum of 5.64% of the asset’s value will impact eligibility for need-based aid.

If, however, the owner of a 529 plan is a non-custodial parent, withdrawals from the plan are counted as student non-taxable income and up to 50% of the value of the withdrawal could impact financial aid.

529 accounts may impact your financial aid at private colleges. Many private colleges use an aid calculation that asks about all 529 accounts that benefit a student, regardless of ownership.

Watch Out for Fees

Some 529 college savings plans have high administration fees that can eat into your earnings. Many plans waive one or more of these fees, or combine them into one "management fee." Since these plans are administered by each state individually, it is possible that your state offers only high-cost funds. These administrative or management fees are usually charged as a percentage of investment, and will grow as your portfolio grows.

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