529 Plans: The Basics

Going back through this blog in an attempt to semi-organize it, I realized I never gave an overview of 529 plans and how they work. That would probably explain all the questions I get about them. So, here are some 529 plan basics.

529 plans are tax-deferred savings vehicles for higher education named after section 529 of the Internal Revenue Code. 529 plans are run by states or higher education institutions. All 529 plans offer two tax advantages:

  • Tax-free growth of funds in the account
  • Tax-free withdrawals, as long as the funds are used for qualified higher education expenses (QHEEs)

Many plans also give tax breaks to their residents for contributions to their state’s plan. Oregon, for example, gives a tax deduction for approximately $4,500 in annual contributions for married/joint filers.

529 plans come in two “flavors”:

  • Prepaid plans allow you to lock in tuition rates in today’s dollars. You buy “credits” at today’s cost which are redeemed for future expenses. These plans are only offered by a few states and the benefits may be limited to certain schools. The plans’ “performance” is a function of tuition inflation.
  • Savings plans are offered by every state and allow participants to invest in mutual funds or diversified portfolios which may be allocated based on the beneficiary’s age. The plan’s performance is the performance of the underlying investments that the participant has chosen.

You can choose any state’s plan for your college savings, and you can have multiple accounts in different states. Some of the factors to consider in weighing different plans are whether your state offers a tax deduction for contributions, what investment choices a plan offers, and plan fees and expenses.

As the parent, you are the account Owner; your student is the Beneficiary. You’ll want to establish an account for each student in your household. You can change beneficiaries, too, so that if your child doesn’t use the full balance in their account, you can use it for a younger sibling or other relative, continuing education for yourself, or hang onto it for the next generation.

And anyone– not just parents– can open a 529 plan for a child. It’s a popular way for grandparents to gift to their grandchildren, especially since the account owner retains control of the account and can therefore ensure that the money is spent for education.

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