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Funding College with 529 Plans

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Funding College with 529 Plans

Over the past decade, tuition and fees at public universities have increased at a 5.6 percent average rate. Individuals understand the need to save for college and are aware that college costs have risen at a faster pace than the consumer price index (CPI) measure of inflation. Yet, a majority of families accumulate far too little money for college by the child’s matriculation date.

One popular way for families to fund college is with a 529 plan, which is a tax-advantaged savings plan used for education expenses. Let’s discuss why its popular and the advantages, but also the disadvantages of using a 529 plan. 

529 Plans

529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. Named for the section of the Internal Revenue Code that authorizes them, encourage saving for future education costs.

There are two types of 529 plans: prepaid tuition plans and education savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a prepaid tuition plan. 

Prepaid Tuition Plans

Prepaid tuition plans let a saver or account holder purchase units or credits at participating colleges for future tuition and fees at current prices for the beneficiary. They usually have to be in-state or public colleges. The plans in most cases don’t include future room and board rates. Also, the plans can’t be used to prepay for elementary and secondary school tuition.

The plans are usually sponsored by state governments and have residency requirements. Some state governments guarantee the money paid into the prepaid tuition plans, but some do not.

A few issues to consider;

  • Prepaid tuition plans do not guarantee acceptance to the college or university. Beneficiaries still have to meet the requirements and be accepted into a program.
  • Plans are not guaranteed by the federal government. 
  • You may lose some or all of your money if the plan’s sponsor has a financial shortfall.
  • If the beneficiary doesn’t attend a participating college or university, the prepaid tuition plan may pay less than if the beneficiary attended a participating college or university.
  • It may only pay a small return on the original investment.

Education Savings Plan

The most popular way for funding college with 529 plans is education saving plans and for good reason. Section 529 education saving accounts can be used for qualified higher education expenses, which includes;

  • tuition
  • fees
  • books
  • supplies
  • equipment
  • room and board

Basically, anything required for enrollment or attendance at an eligible educational institution for a beneficiary who is at least a half-time student. Withdrawals from education savings plan accounts can be used at most colleges or universities, including at some non-U.S. colleges and universities. Unlike prepaid tuition plans, they can be used for tuition at any public, private or religious elementary or secondary school.

Here are some of the positives to consider;

  • Investments in a 529 plan grow tax-free as long as they are used for qualified higher education expenses.
  • Proceeds from the plans are not taxed at distribution as long as they are used for college expenses.
  • The funds in a 529 plan are not transferred into the name of the student when they turn 18, allowing a parent to retain control of the funds if the student opts not to attend college.
  • If parents are owners of the plan, they can change beneficiaries on a 529 plan to immediate family members, including other children, siblings or cousins.
  • There are no income restrictions on contributions.
  • State residents who contribute to or are the beneficiary of that state’s plan may gain state income tax benefits.
  • Contribution limits are high.
  • Proceeds can be used nationwide.
  • There are estate and gift tax benefits.
  • Often plans are open to residents of any state.
  • The initial minimum investment is low.
  • Maximum account balances vary by state; new contributions are not allowed when an account reaches the maximum balance. They generally are around $250,000.
  • Funds can be transferred from one plan to another once every 12 months.
  • American Opportunity Tax or Lifetime Learning Credit can be claimed in the same year as a qualified withdrawal from 529 savings account as long as the same educational expenses are not used to justify both benefits.

A few issues to consider;

  • Management of a 529 plan is typically restricted to mutual funds or annuity accounts as dictated by individual state controls.
  • These plans have an impact on the availability of financial aid as they are held under the control of a parent or guardian for the life of the investment.
  • It is not optimal from a financial aid perspective as it will cause the asset to be reported on student financial aid as long as the student is a dependent.
  • College costs paid for by 529 plan distributions can not be used towards either the Hope Scholarship or Lifetime Learning Credit.


As for personal finance goals, most families have concerns about future college expenses. Don’t worry, with proper planning you can start setting money aside, much like an emergency fund. Funding college with 529 plans are popular and have many benefits. However, 529 plans are not for everyone and certain families there are reasons to reconsider. Either way, talking with a financial planner about your children’s future is important and should be discussed sooner than later. They have the education and experience to help you make the best decision.

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