Introduction to 529 College Savings Plans

Thanks to recent actions by the United States Congress, 529 plans enjoy permanent tax advantages that make them ideal for many people saving for college.  Parents and grandparents can contribute to 529 college savings plans and not have to pay tax on the earnings when withdrawn for qualified education expenses.

There are two types of 529 plans: college savings plans and pre-paid tuition plans. 

• College savings plans are the most common and most flexible.  Essentially, you contribute funds to the plan over time and can withdraw it tax free to pay for your college education wherever you decide to attend.
• Pre-paid tuition plans are generally state plans that allow you to "lock-in" the price of education at a specific college now.  These plans can be limited and require you to enroll in a state college

Tax Advantages

No one likes to give Uncle Sam more money than they have to.  And that's a big benefit of 529 plans.  Earnings from 529 investments aren't subject to federal income tax.  If you invest in your state's 529 plan you often don't have to pay state income tax on your 529 earnings too.  Some states even offer upfront tax benefits for investing in the plan.

If you live in a state that levies an income tax, it may make sense to invest in your state's plan.  However, most 529 plans are open to all United States residents.  You should shop around to find the best plan for you.

Unlike many retirement savings plans, there are no "income phase outs" to prevent high net worth families from investing in 529s and reaping the tax benefits.

529 Fees

Each state plan has different fees, so you should shop around before deciding on 529 plan.  Many states offer multiple plans with varying fees.  Broker-sold 529 plans often carry loads.  If chosen carefully, 529 plan expenses can be competitive with other financial investment plans. 

Investment Limits

Each 529 plan has investment limits.  Some apply annual limits as well.  However, these are generally high enough to cover even the most expense colleges and ivy league universities. 

Furthermore, 529 plans have no income restrictions in order to contribute.

Alternatives to 529 Plans

529 plans are not the only options for saving for college.  However, the permanent tax break on these plans make them a popular choice.  Other college savings plans include:

• Coverdell Education Savigns Account (CESA) - contribute up to $2,000 a year.  Families earning more than $190,000 a year have limited contributions.
• Custodial Accounts (UGMA/UTMA) - contribute up to $12,000 a year ($24,000 for couple) without federal gift tax.  Earnings are taxed at child's tax rate.