The 529 Plan is a savings plan operated by your state to help you save for college-incurred costs. Generally, they are available to any U.S. resident in any state. 529 is the code number of the IRS law under which these plans are covered. While a student is filling out scholarship applications and the FAFSA, he should also consider any money he has saved in a 529 plan.
The best part about a 529 plan is that the money you invest grows tax-free. Current legislation will keep these earnings tax-free until December 31, 2010. After that, lawmakers will decide whether to extend the 529 code at that time for the savings to continue to grow tax-free.
When the student is ready for college, the distribution from the plan that goes toward college is also tax-free. When the student is ready to go to college, any funds withdrawn from the qualified 529 plan will be distributed 100 percent federal income tax-free if the monies are used for qualified higher education expenses.
If funds are withdrawn and used for any other purpose than education, you will be assessed a 10 percent federal tax penalty.
Some states also let you decide how the money in the 529 plan is invested. Other states or plans might give you a few options on what you can invest in based on your goal for the account.
It is very important to check with your state about residency requirements, minimum contributions and fees. Each state runs its own plan and has different regulations regarding 529 plans. You can find this information at your local bank or credit union. You may also need to research how a 529 plan can affect your eligibility for financial aid when you fill out the FAFSA.
529 Plans for Consideration
The two types of 529 plans are the college savings plan and the pre-paid tuition plan. There should be at least one type of plan offered by your state if you live in the U.S. There are some big differences between the two plan types.
Pre-Paid 529 Plans
Pre-paid plans let parents buy credits from certain colleges to use toward tuition in the future. State governments usually sponsor these plans, but they also have a residency requirement. The child must go to a university or college within the state. One great advantage to a pre-paid plan is that you can lock in today’s tuition rate, which is less expensive than tuition rates 18 years from now. Most pre-paid plans only cover the cost of tuition and applicable fees – not room and board. You can choose the amount for your installment payments, which remain steady through the years. By the time the child is 18, there should be enough money to cover most of the college costs.
College Savings Plans
College savings plans are more popular. A parent or guardian can start a savings account for their child to use toward college expenses. He or she has the option of choosing different investment plans to increase the account balance. Typical investment plans include stocks, mutual funds, bonds, etc. As the child gets older, the investments become more conservative. The downside to these plans is the investment risk and the fact that they are not guaranteed or insured. In other words, you could potentially lose money in the college savings plan. An advantage to this type of plan is that the money can be used for any type of college expense, including rent, food, books, and school supplies. Most college savings plans have very high limits, so the parent can deposit hundreds of thousands of dollars if he or she desires. One thing to consider with 529 plans is that these plans must be reported on the FAFSA when you fill it out.