What is a 529 College Savings Plan?

by Scott Sery on May 29, 2012

Education is one of the greatest tools a person can use to get a jump start on their career.  By getting a good education they can bypass years of on the job experience.  Unfortunately, education costs are often expensive.  Thankfully there are ways for parents and grandparents to save up for their loved one’s education.  The 529 plan offers some great tax benefits, but it also has a few drawbacks.  Whether or not one should be used depends a lot on the individual situation.

There are two basic types of 529 plans.  There is a pre-paid tuition plan, which is rarely used, and there is the more common college savings plan.  Both allow a person to set aside money for education costs, and both provide excellent tax benefits.  After a person has decided to use a 529 plan, they must then decide if they want to use a state plan, or an out of state plan (note: this is not for an out of state college, however, it is a plan sponsored by a state other than that where the account owner lives).

Money that goes into these college savings plans is deposited after tax has been paid.  Once in the plan the accumulations grow tax deferred.  As long as the money is spent on qualified higher education expenses, including tuition, room and board, books, and other college necessities, the money will not be taxed federally.  However, if the money is used otherwise, the government will often impose a 10% penalty as well as regular income tax.   State plans will often get a break on state taxes as well, for those investing in an out of state plan, they most likely will not see these state tax breaks.

One of the biggest drawbacks of the 529 plan is the uncertainty that comes with it.  If the child is gifted and earns scholarships, they may not need to use the money for education expenses.  On the other hand, if they choose not to go to college, they will not need the money either.  A state plan is enticing because of the tax benefits, but often the plans do not offer the investment options the individual would like.  Finally, the accumulated savings might actually affect the student’s ability to get financial aid.  With so many variables, the individual should carefully consider whether or not the plan is right for them.

When making the decision to open a 529 plan, you should keep in mind that you control the funds, not the child.  At any point you can change the beneficiary of the account, so if the first child does not use the money it can be switched over to another child.  Unlike when planning for retirement there is no limit on how much can go into a 529 college savings plan.  So for most, the contributor can do as little as $50 per month or as much as a lump sum in the 6 figures.  The bottom line is that it is best to get some basic information, and then talk with a trusted advisor if this is the right account to open for your loved ones.

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Scott Sery

Scott Sery is a native to Billings, Montana. Within an hour in nearly any direction he can be found fishing, hunting, backpacking, caving, and rock or ice climbing. With an extensive knowledge of the finance and insurance world, Scott loves to write personal finance articles. When not talking money, he enjoys passing on his knowledge of the back country, or how to live sustainably. You can learn more about Scott on his website ScottSery.com

Latest posts by Scott Sery (see all)

  • http://www.modestmoney.com/ Modest Money

    Sounds like a good option if you want to help pay for your child’s education. I didn’t realize that this savings could possible affect financial aid though. That part would be frustrating.

  • http://www.mymoneydesign.com/ MyMoneyDesign

    I’m a big supporter of 529 plans. I have one setup for each of my kids. Regardless of how much they return, I like the idea of being forced to automatically stash away money each month towards this goal.

  • http://fromshoppingtosaving.blogspot.com/ From Shopping to Saving

    Good to know!! I definitely want to start one for my future kids. I had no idea that it could be transferred to another child though!

  • http://twitter.com/familymoneyblog John Preston

    I have 529′s for my kids and they are great, but I do worry about how much to save in them. I don’t want to over-save my 401k. You definitely should be conservative with what you put in them.

  • jefferson @seedebtrun

    i love the 529 plans.. we are planning to fire one up for all 3 of my kids, as soon as we are free of debt.

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