A 529 plan is a tax-advantaged savings plan named after Section 529 of the Internal Revenue Code. The intention of 529 plans is to encourage college savings. Every state and the District of Columbia, and even some educational institutions sponsor a 529 plan. There are two types of 529 plans: college savings plans and pre-paid tuition plans. Investment options, expenses and other specifics vary from state to state.
Pre-paid tuition plans
While states can offer both types of 529 plans, educational institutions can only offer pre-paid tuition plans. With a pre-paid tuition plan, you are effectively purchasing a future education at an in-state public institution at current prices. In some cases, you can also pre-purchase room and board expenses. State governments typically guarantee investments in pre-paid tuition plans, and require either the owner or the beneficiary to be a resident to benefit from the plan.
College savings plans
Your contributions to a college savings plan function somewhat like an Individual Retirement Account. In a college savings plan, the investments you choose are subject to market risk with no guarantee that it will increase in value.
When the student is ready to use the funds for school, you can make withdrawals up to the amount of qualified higher education expenses. College savings plans typically have fewer limitations in terms of the age or residency of the account owner or beneficiary and does not restrict your use of the funds to schools within your state. Additionally, college savings plans generally have more varied investment options.
Tax benefits of 529 plans
For both types of 529 plans, contributions are not tax-deductible; however, you never have to pay tax on the income your investment earns each year. And as long as you make withdrawals only to pay for qualified higher education expenses, you will never pay income tax when you put the money to use. Qualifying expenses typically include books, tuition, mandatory fees, room and board and any necessary equipment.
Owners retain control over plan
With a 529 plan, the owner remains in control of the plan, and the beneficiary or student has few, if any, rights. As the owner of a 529 plan, you have the right to change the beneficiary of the account at any time, and you can choose where and when to make distributions from the account.
Subject to the options available in your specific plan, you can choose where to invest the money in the account. If you are willing to pay taxes and penalties, you can even reclaim the balance of the account at any time without your beneficiary's permission.