20 Short Facts about 529 Plans (Part 1 of 2)
INTRODUCTION
1. A 529 college savings plan is a tax-favored plan that allows you to save money for college.
2. "529" refers to a section in the Internal Revenue Code (here).
3. Each state has a 529 college savings plan (most states have more than one), and you can enroll in the 529 college savings plan of any state.
4. The 529 college savings plan discussed here (and hereinafter referred to as a "529 plan") differs from a prepaid tuition plan, which is referenced in the same section of the Internal Revenue Code. As its name suggests, a prepaid tuition plan allows you to lock in tuition rates at a state college.
5. With a 529 plan, you make deposits into an account. Those deposits are then invested (and hopefully grow). You can then use the money in your 529 plan account to pay for "qualified higher education expenses": tuition, room and board, mandatory fees, books.
ADVANTAGES
6. Tax advantage #1: Earnings on assets deposited into a 529 plan account are not subject to income tax.
7. Tax advantage #2: You don't pay income tax on assets withdrawn from a 529 plan account for qualified higher education expenses.
8. Tax advantage #3: In some states (like Illinois), if you enroll in a 529 plan in the state where you reside, you get a state income tax deduction for contributions made to the 529 plan.
DISADVANTAGES
9. Disadvantage #1: It may be hard to wade through all of the different state 529 plans, which have differing managers, fees, etc.
10. Disadvantage #2: Once you are in a 529 plan, investment options may be limited.
11. Disadvantage #3: This is the biggie -- the fact that if you withdraw assets from a 529 plan account for something other than qualified higher education expenses, you get a double whammy. The earnings portion of the amount withdrawn IS subject to income tax, PLUS there's an additional tax equal to 10% on this portion. Some states have additional penalties. The general problem here is in guesstimating how much you'll need to sock away. If I save too little, then I haven't taken full advantage of my 529 plan (and I'm on the hook for my daughter's education). If I save too much, what happens if she goes to a fairly inexpensive state school? Or decides to skip college altogether?
[Note: Edited to make it clear that the income tax and the 10% penalty apply only to the earnings portion of the amount withdrawn.]
