What is a ‘529 Plan’

529 is a category of plans that provide tax advantages when saving and paying for higher education. There are two major types, pre-paid tuition plans and savings plans. Pre-paid tuition plans allow the plan holder to pay for the beneficiary’s tuition and fees at designated institutions in advance. Savings plans are tax-advantaged investment vehicles, similar to IRAs. Rules governing the plans are laid out in Section 529 of the Internal Revenue Code. They are legally referred to as “Qualified Tuition Programs” and sometimes called “Section 529 plans.”


There is no limit on the number of 529 plans an individual can set up, but contributions cannot exceed the cost of education. Distributions from all 529 plans are exempt from federal income taxes, although contributions are not deductible. Annual contributions of over $14,000 are subject to federal gift taxes.

The market for plans is competitive, and most states do not require the plan holder to be a resident or the beneficiary to attend an institution in the state. However, some pre-paid plans do have these requirements. States’ plans generally offer their own tax benefits. For the most part these perks only benefit residents, but a few states match the benefits of whatever plan a resident opts for.

Eligible expenses vary depending on the plan. Tuition costs and mandatory fees can always be covered by distributions. Savings plans can be applied to room and board, textbooks and some computer equipment. A few pre-paid plans apply to room and board. 529 plans cannot be used to pay for student loans. Distributions that are not used to pay for qualified educational expenses are subject to taxes and a 10% fee, with exceptions for circumstances such as death and disability.


The assets of a plan belong to the plan holder, not the beneficiary (although these can be the same person). The beneficiary has no claim on the assets, which can be withdrawn by the holder for any reason at any time, with penalties. A plan can be transferred to a member of the beneficiary’s family, or excess funds can be rolled over into a family member’s plan. Neither action triggers a penalty or taxes. Although the beneficiary does not control the plan’s assets, these may affect his or her financial aid eligibility to a significant degree. The plan’s assets are generally not counted as part of the plan holder’s estate, so 529 plans confer estate tax benefits.

Savings Plans

Savings plans, which are only offered by states, are similar to IRAs in that they are tax-advantaged ways to invest money in the long term. Plan holders usually have the option to invest in a range of mutual funds. These funds may be targeted to the date beneficiary is expected to start their education and attempt to reduce risk exposure as the date approaches.

Pre-paid Tuition Plans

Pre-paid tuition plans are offered by states and higher education institutions. In a way, they’re analogous to futures contracts: they allow the plan holder to prepay for one or more semesters at designated colleges or universities at current prices. This shields them from inflation in tuition costs, which has historically been much steeper than broader measures of inflation.

Pre-paid plans differ in their specifics, but often have limitations that do not apply to savings plans, such as age caps and residency requirements. They often have stricter limits on what expenses they can cover: textbooks or room and board may not be eligible. On the other hand, some are guaranteed by states, while savings plans are subject to market risk.

There is one non-state pre-paid plan, called the Private College 529 Plan (formerly the Independent 529 Plan), which allows holders to prepay tuition for a consortium of private schools. One problem with this plan, as with state plans, is that the choice of schools is limited. If the beneficiary does not attend one of the selected schools, the funds may be rolled over into another plan, causing them to forfeit most of their gains. Alternatively, they can be transferred to a family member of the beneficiary or rolled over into that beneficiary’s plans, which involves no penalty.


529 Strateges That Maximize Student Aid Options

College isn’t cheap. Anybody who is in college, was in college or is currently saving for college already knows that. What you might not know, however, is how fast the costs are rising. The accepted rule of thumb is that the cost of college increases at about twice the rate of inflation. That means that each year, you can expect to pay at least 5% more.

If you’re a parent of a future college student, you have to save now, but tucking money away in a savings account isn’t going to work. You have to invest it to stay ahead of inflation. Most people turn to a 529 savings plan to make their money grow. That will help a lot, but what parents may not know is that how they later spend the money is just as important as how they save.

In the best possible scenario, you would combine 529 funds with help from the government to cover the complete cost of college for you or your child, but government help is often income-based and that’s where handling those 529s strategically comes in.

When and How to Spend 529 Funds

Recently, a Wall Street Journal columnist advised that once a child reaches college, it might work to the family’s advantage to spend all 529 funds in the first two years in the hopes of getting financial aid in the third and fourth years – if the parents expect a high-expense or low-income year. Good advice? We decided to check it out with other experts. The variety of advice we found made it clear that parents should consult a college loan expert for the correct advice for their situation.

Cash out quickly, if you’re a student or parent. Gretchen Cliburn, CFP, Senior Managing Advisor at BKD Wealth Advisors in Springfield, MO, says, “Money held in 529 accounts owned by the student or one of their parents is considered to be parental assets on the FAFSA. If you know your education costs will exceed your 529 savings, I would recommend spending the 529 balance first before borrowing any money.”

But not if you think you might have trouble getting a loan later on. Running through 529 funds in the first two years – instead of taking advantage of available loans – can backfire, says Joseph Orsolini of College Aid Partners. “Families really need to budget out the four years of college to determine the best course of action with spending savings and borrowing. I have seen a number of families spend down their 529 accounts in the first couple of years, but later run out of money and not be able to borrow (due to bad credit) in the final years,” he warns. “These students are left without resources to finish college.”

Orsolini agrees. “Low income is a relative term for people. Dropping from $150k to $100k is a huge reduction, but in most cases it will not result in any additional financial aid,” he says. “If your child is at an elite college that matches 100% of need, it might be worth relying on this strategy, but most colleges will not increase an aid package simply for spending down your 529 fund.”

Hold back, if you’re a grandparent. There are circumstances when it might be best to refrain from using the money until the student’s later years, according to Ryan Kay, a certified financial planner. “One important aspect to remember while considering when to spend the 529 money is who owns the plan,” Kay says. “If a grandparent is the owner, for example, and he or she distributes funds from the 529 plan, the money will count as student income for next year’s FAFSA and could negatively impact the student’s ability to qualify for financial aid. So when the grandparent is the owner, often times it’s best to leave the money in the 529 plan until the student has filed the final FAFSA (January 1 of their junior year of college).”

Factor in the Tax Credit

The American Opportunity Tax Credit offers a tax credit of up to $2,500 when you have spent $4,000 on tuition, fees, textbooks and other course materials. However, it phases out at certain income levels ($180,000 for married couples filing jointly in 2015, for example). Also, you can’t use the same expenses to justify both a tax-free distribution from a 529 plan and take the tax credit – there’s no double dipping.

“The tax credit is worth more per dollar of qualified expenses than the tax-free 529 plan distribution, even considering the 10% tax penalty and ordinary income taxes on non-qualified distributions,” says Mark Kantrowitz, publisher and VP of Strategy, Cappex.com. “Families should prioritize $4,000 in tuition and textbook expenses to be paid for using cash or loans before relying on the 529 plan. Otherwise, [it’s preferable] to spend down the 529 plan balance as quickly as possible, so that the assets do not persist year after year to reduce aid eligibility by 5.64% of the asset value.”

The Bottom Line

Like most financial questions, there are a lot of what-ifs, but in general, our experts recommend other practices rather than spending all the 529 money now and betting on the future. However, for some people, they note, the strategy could represent a cost savings.


5 Secrets You Didn’t Know About A 529 Plan

College isn’t cheap and the costs are rising fast. If you don’t start saving for your children as soon as possible, their chances of having sizable student loan debt after graduation is high.

The 529 plan is a tax-advantaged investment plan that you set up to help multiply your efforts. There’s lots of basic information about these plans, but here are some facts you may not know.

Growing Your 529

1. Donors Can Invest Up to $14,000 per Year

If you have a wealthy benefactor, such as a grandparent, who wants to invest a large amount of money into the fund, that may not be possible. The official IRS language is, “Contributions can not exceed the amount necessary to provide for the qualified education expenses of the beneficiary.” In addition, any individual gift over $14,000 is likely to trigger gift taxes.

In reality, you probably won’t have to deal with gifts that large. If you do, it’s best to talk to a tax professional about the maximum possible investment. The laws surrounding gift taxes are complicated.

2. You Can Receive Funds at Any Age

The 529 plan is normally used by parents of young children who want to have a substantial amount to pay for their child’s college expenses, but there is no age limit on the beneficiary. If you plan to go back to school sometime in the future, starting a 529 for yourself may make sense.

3. It’s Not Just for Tuition

A 529 plan doesn’t just cover tuition. The IRS says that it covers eligible expenses. These include books, computers, room and board, and Internet service. If a meal plan is included in the price of tuition, that’s covered, and if you have to eat out because the dining hall isn’t open, you could use the money for that as well.

A good rule of thumb is, if you are required to have something as part of your college education, you can probably use 529 funds to purchase it.

What’s not covered: transportation to and from school, expenses related to elective activities such sports and clubs, and entertainment costs.

4. Save More Than $300 per Month

The sobering truth is that from the time your child is born, plan on contributing more than $300 per month if you want to cover his or her college costs. Assuming that grants, scholarships and other aid will cover part of the bill, you could plan on covering about 80% of the cost.

If you figure that the cost of college with rise about 4% annually – and you will earn about 6% on your contributions – you have to contribute about $372 each month until your child graduates from college to meet your goal. If you start much later, you have to contribute more. Use this calculator to figure out your contribution rate.

5. Most 529s Are Stock-Based Funds

Eighteen years isn’t very long to accumulate a six-figure stash for college so your money has to go into stock-based investments. That’s good because it allows for bigger gains – 6% or more – but it could also allow for big losses. In 2008, during the stock market crash, the average 529 plan lost 24% in the one year alone. Because savers can only make changes to their investment allocation once per year, people were often powerless to protect themselves.

There’s little you can do to avoid the risk, but have a backup plan in case the markets enter a period of correction that causes a major decline just when you need the money.

The Bottom Line

Despite the risks, a 529 plan is still better than a regular savings account for building wealth. The returns on a savings account aren’t adequate and you have to pay taxes on them. Regular investment accounts give you more options and liquidity but since they aren’t tax-advantaged vehicles, the returns aren’t as good.


529 Risks to Take (Or Not)

When you first start to delve into the fine print of tax-advantaged 529 plans – typically shortly after your first baby’s birth – it’s daunting. It feels as though there are at least 529 different options, rules and regulations for these funds. Actually, the 529 nickname comes from Section 529 of the Internal Revenue Code, which allows contributions to grow tax-free if used for qualified educational expenses.

Should You Choose a 529 Plan?

A 529 is one of a variety of ways to accumulate tax-advantaged savings for college. Other options to investigate for tax-advantaged college savings, according to the U.S. Securities and Exchange Commission are Coverdell education savings accounts, Uniform Gifts to Minors accounts, Uniform Transfers to Minors Act accounts, tax-exempt municipal securities and savings bonds.

Saving via a 529 plan is especially advantageous if you live in one of the 33 states (and the District of Columbia) that give you a state tax deduction for your contributions in addition to the federal benefits. Some of these deductions are lush: On the high end they range from $10,000 per contributor for Oklahoma and Mississippi up to Pennsylvania’s double whammy: $13,000 per contributor per beneficiary. See Top Strategies for Saving In A 529 Plan for details on which states and other information, and click here for additional state information.

The more closely you focus on finding the One Best Way to accumulate the money your baby will need to go to college, the more complex the decision becomes. It’s tempting to just shuffle the brochures into your bottom desk drawer and bookmark the websites in your “read later” folder to worry about later.

You are now facing the first and biggest risk of all college savings plans.

RISK # 1: Doing nothing while time is most on your side.

Weigh the following facts. In this age of runaway tuition, college costs clock in with far higher rates of inflation than the overall economy. As of September, 2014, FinAid.com’s College Cost Projector put the tuition-inflation rate at 7.0%; in recent years it has ranged from 5% to 8%. By contrast, the US Inflation Calculator, using the Current Consumer Price Index, put the overall economy’s inflation at 1.7% for the 12 months ending in August 2014.

Meantime, the return on a regular savings account lags notably behind both rates. For “highest yield” money market and savings accounts opened with $10,000, for instance, Bankrate.com puts most banks’ rates of return at or under 1.0% – and in some cases, as low as .25 or .15%. You’re going to need those tax advantages to boost the return on what you put away. Because the power of compound interest increases with time, the sooner you start, the better.

Strategy: Don’t let “paralysis of analysis” rob you of the benefits of an early start. Through your employer, you usually can open a automatic deposit payroll plan with as little as $25.

Which 529 Plan?

This article will focus on how to manage your 529 plan funds. First, a quick 529 tutorial. There are two kinds of 529s: savings plans and prepaid tuition plans.

Savings Plans. Although the bigger category of 529s is referred to as the “savings plan,” in reality it’s an investment plan supervised by an official of the state whose plan you contribute to, generally the state treasurer or comptroller. The state usually subcontracts plan operation to a financial service such as Upromise, JP Morgan Asset Management or Vanguard, among many. The money you contribute is invested through one or more state funds that are much like a mutual fund, and each state has its own rules.

Tuition Plans. If you’ve been scared by the stock market’s tumbles, you may find the other, smaller category of 529s more attractive. A prepaid tuition 529 plan means that rather than having your savings subject to the uncertainties of the stock market, you use today’s dollars to buy tuition credits – say, a certain number of course hours – to be used for your children’s college educations. They are like vouchers. (Room and board fees are not covered in 529 prepaid-tuition plans, though, so part of your cash still should go into a 529 savings plan for that purpose.)

Each of these plans subjects you to some built-in risk. Managing your 529 plan funds requires choosing whether to save in one or both plans and thinking your way through the challenges of handling them.

RISK # 2: You choose the 529 savings plan, instead of the prepaid tuition plan, and the market falls when you need the cash.

When you choose the savings-plan route, you are betting that your fund’s investment portfolio will do well enough to raise the money you need. The Big Bad Wolf of savings-plan management is overall market volatility, more than the poor performance of a particular fund. The other challenge is how much time you are willing to spend managing that money.

Strategy: One place to get some help – age-based funds, a category usually offered along with more growth-oriented options. Also called age- or time-targeted, these managed funds adjust their investment strategy based on when you plan to withdraw money to pay for college. The longer your lead time, the more aggressive or high-yield the fund investments can be; the sooner you need it, the more conservative the investments, ensuring some money even if the market falls. This targeted strategy does not remove all risk but it minimizes risk intelligently – and automatically.

Big caution: Watch for fees. Age-based funds are managed funds, and many have very high fees. Here’s where to find reports on which 529 funds have the lowest fees on Savingforcollege.com. Search further for age-based funds and you’ll find they aren’t the least expensive type. Choosing them involves a tradeoff.

RISK # 3: You lock in prepaid tuition, but its one size does not fit (at) all.

Let’s say you buy into the concept of “tomorrow’s tuition at today’s prices.” You see it as an advantage that you don’t have to manage the growth of the money, the state does it – just like a pension plan. But not only is the number of states offering prepaid tuition plans shrinking, some plans are dangerously under-funded – again, just like pension plans.

Similarly to paying points upfront on a mortgage, usually you pay a premium over today’s actual prices to purchase prepaid tuition credits, but it can still seem like a pretty good buy. The promotional language is usually very persuasive, yet as Forbes reports, most states do not actually guarantee that your prepayment will cover the actual college tuition for your child when the day comes (Florida, Massachusetts and Mississippi are among the few that do). Especially in states with austerity-minded legislatures that are cutting education costs to the bone, you may end up with sizable extra assessments and new “fees” to cover funding shortfalls.

And then there’s the delicate matter of school choice and student performance: How likely is it that all your kids will want to go to the college you pick for them? How sure can you be that they will all get into – or through – that college?

If you don’t know the song “Plant a Radish” from The Fantasticks, this would be a good time to track it down on on YouTube. It’s from the longest-running musical in the world – the first off-Broadway production ran for 42 years. “Plant a carrot, get a carrot, not a Brussels sprout,” the fathers sing, “while with child-e-ren, it’s bewild-e-rin.’ You don’t know until the seed is nearly grown, just what you’ve sown.”

The downside of prepaid plans is their lack of flexibility. Usually the student must be attending the school at least half-time for the credits to be applied, for instance. Frequently it’s far from easy to transfer prepaid tuition credits to other schools even in the same state, and rarely can you redeem them or get close to full value except at the designated institution. The plans have “a history of difficulties,” says Reuters.

Strategy: Putting part of your family’s college money into a prepaid tuition plan may indeed turn out to be the best buy, but preserving flexibility by putting the rest into a 529 savings plan savings can be an important hedge.

Also helpful is the ruling that the beneficiary (or beneficiaries) of a 529 plan can be changed once a year, as long as you keep it all in the family. The IRS calls this a rollover and is very specific about who qualifies as family:

1. Spouse

2. Brother, sister, stepbrother or stepsister

3. Father or mother or ancestor of either

4. Stepfather or stepmother

5. Son or daughter of a brother or sister

6. Brother or sister of father or mother

7. Son-in-law, daughter-in-law, father-in-law,

mother-in-law, brother-in-law or sister-in-law

8. The spouse of any individual listed above

9. Son, daughter, stepchild, foster child, adopted child

or a descendant of any of them

10. First cousin

Risk # 4: Your 529 money has to be diverted to a critical – but non-qualified – expense, instead of used for college.

Your contribution is not irrevocable. As the owner of the account, if you need to repurpose the money in a 529 savings fund for something that’s not education-related, you can do so. There are some penalties: You’ll lose the tax benefit and must repay any state tax deductions based on contributions, plus a 10% federal penalty on earnings. All the same, you can reclaim the principal: It still belongs to you. Having the financial penalty in place is a good psychological barrier to keep you living within the restrictions of the 529 rulebook, but sometimes priorities must change.

Strategy: Another layer of protection for college funds is to have an adequate emergency fund readily accessible – usually calculated as enough to cover three to six months of normal expenses. Use that before breaching your 529 plan.

Risk # 5: The state 529 fund you pick delivers a weak performance.

Well-diversified holdings in the 529’s investment funds offer some protection against bad markets – and past performance may give you some guidance on which investments to choose – but the most control over your earnings comes from scrutinizing the fees within your 529 plan.

The larger management fees and fund-overhead charges of brand-name operators can cost you as much as a full point, or even slightly more, off your investment return rate. Many are charged up front, before your money goes to work. They may sound small – a quarter-point here, a half-point there – but over time their inroads add up to serious money.

Strategy: Comparison-shop for both direct-sold funds and private funds. Although only states offer prepaid tuition plans, private financial firms and even college consortiums offer qualified 529 savings plans. You do not have to use your home state’s 529 savings options. In fact, Virginia – the 12th state in population, but 35th in geographical size – has what MSN Money.com calls “the country’s largest plan, with nearly $30 billion in assets.” That plan, Virginia’s CollegeAmerica 529 Savings Plan, can be bought only through financial advisers and has ranked high in Morningstar’s recent ratings.

An independent financial planner – one working for a fee paid by you rather than a commission paid by a for-profit entity – can evaluate the lowest-fee, direct-sold funds for you and keep on top of deadlines and deductions. You can mentally write off the fee as necessary overhead, and you’ll probably see actual cash savings over the long run.

Which brings us to the last risk category, which is …you.

Risk # 6 : You’re not good about saving money.

In today’s defined-contribution, 401(k) world, you are a potential risk to your children’s chances of graduating without crippling education debts, to your own comfortable retirement, and possibly to your long-term self-respect and family harmony if you can’t get a grip on saving money. There’s a new strategy that could make the process a little more palatable, especially if you’re the type who’s more likely to buy a lottery ticket than park spare dollars in a bank.

The new savings vehicle: prize-linked savings accounts. Your minimum deposit doubles as a qualified ticket in a lottery or sweepstakes that gives randomly chosen winners a cash reward, usually from a long list of small prizes and a short list (maybe even just one per month) of flashy, big-number prizes. Credit unions in a growing number of states (at least five as of this writing, according to the New York Times) are setting up these accounts, and federal legislation is in the works.

Your deposit stays in the savings account, but you can walk away with the extra cash from the prize. It’s quite an odd couple: The thrill of gambling subsidizes the sedate pleasure of thrift.

Research reported in 2013 by the Heritage Foundation prompted the think-tank to label this development “a potentially important approach to building a habit of savings among Americans in lower- and moderate-income households.” Major private funders including W.K. Kellogg, The Ford Foundation and the Walmart Foundation for Funding are putting money into these projects, as are smaller philanthropies such as Pittsburgh’s Grable Foundation and Benter Foundation.

One prize-linked savings group, Save to Win, already has 62 participating credit unions and is honing its offerings to find the best magic formulas to attract and reward previously intractable nonsavers. PBS NewsHour calls it “a lottery where you can’t lose.”

That’s true, although if you don’t win a prize, your savings that remain in the plan are not accumulating the earnings growth of conventional 529 plans. Solution: Don’t leave them there.

Strategy: After a year – or whatever time period the particular prize-linked account designates – roll over the balance into a qualified 529 plan for the beneficiary of your choice. Your college savings fund is launched. After that, you can either start making additional deposits directly into your new 529 or funnel them through the prize-linked savings account in periodic increments.

The Bottom Line

While tax-advantaged 529 savings and prepaid tuition funds have their pitfalls, the alert plan owner can offset the risks with smart strategies and informed choices. There’s a tax-wise option to suit almost everyone.


Investing In Your Child’s Education

Let’s face it: with steadily rising expenses in our daily lives, raising children is becoming more and more expensive. Forget about the $300 PlayStations, the $5 G.I. Joes or even the $30 Barbies. The growing concern for many parents is their financial readiness for sending their little and not-so-little ones to a post-secondary institution. Tuition costs alone are ranging between $5,000 and $30,000 per year, and the average degree requires four years to complete – provided, of course, that the kids don’t decide to change majors or take their sweet time graduating. By the time we factor in the costs for books, spending allowances, housing and food, the total bill may be in excess of $50,000.

This is a significant amount of money for most people, and many of us are simply not ready for such a financially draining situation. Some parents aren’t even aware of its severity until it’s too late – when their children have only a few years left until high school graduation! Others may hope that their kids inherited the “smart” gene from old Uncle Bill and will earn plenty of scholarships to pay the costs.

For those of us who don’t have that much faith in genetics, don’t even have an “Uncle Bill”, or aren’t financially independent enough to cover the associated costs of sending kids to post-secondary institutions, there’s another way. The U.S. government, realizing that these costs have been increasing steadily over the past few decades, has provided ways to make saving for educational fees easier. Presently, there are three popular methods whereby you can increase savings benefits and earn enough money to pay for your children’s costs.

Coverdell Educational Savings Account
Formerly known as an Education IRA, the Coverdell account benefits parents and children as it provides a tax shelter for capital gains. In 2001, Congress passed a bill that allowed parents to increase annual contributions, depending on their income, to up to $2,000 per child. Thus, families with only one individual filing an income tax return less than $95,000/year are allowed to contribute $2,000/year per child. If the amount you file is between $95,500 and $110,000, the contribution limit is $1,800/year per child, and, if the amount you file is above $110,000/year, you’re out of luck: the contribution amount is $0. If the family income has joint filers, the income limits are doubled with the contribution limits remaining identical.

Withdrawals from this account are penalty-free if they are made for qualified educational expenses, and are taxed as income at the beneficiaries’ tax rate. Additionally, this account provides flexibility in investment content, and, should the beneficiary not require all the funds within the account, the remaining portions can be changed to the name of any other family member below 30 years of age. The one drawback of this type of account is that, if the beneficiary applies for financial aid, the assets within the account are designated as those of the beneficiary.

Using a child’s social insurance number, an adult can open an account on behalf of a minor and act as the custodian of the account. Contributions by any single individual to a minor can be up to $11,000/year. If the minor is below the age of 14, the first $700/year is tax-free, the second $700/year is taxed at the child’s rate, and anything above $1,400 is taxed at the parent’s rate. If the minor is above 14 years of age, any investment income over $700/year remains taxed at the child’s rate.

These UGMA/UTMA types of accounts provide flexibility as the funds do not have to be used solely for educational purposes; however, these accounts do have substantial drawbacks. First, the custodian has limited power in controlling what the assets are used for once the power of the assets is transferred to the beneficiary. What this means is that after the beneficiary legally becomes an adult, the funds are transferred into the beneficiary’s name and he or she can use the funds for whatever he or she wishes, regardless of the contributor’s approval. Second, there is no tax shelter as capital gains are taxed regularly, albeit at the beneficiary’s rate, which is typically lower than that of the contributor. Third, as with the Coverdell account, these assets also count against the beneficiary who, possessing ownership, decides to apply for financial assistance for higher education.

Education 529 Plan
This is a service provided by all 50 states within the United States. These accounts create an educational tax haven for beneficiaries. Any gains within the account accumulate tax-exempt, and distributions for education-related expenses are also untaxed. Anybody can open one of these plans, contribute to it, and be listed as a beneficiary. Unlike the donors of the UGMA/UTMA accounts, the donor of the 529 plan is always in control of the money and can generally change beneficiaries without much difficulty; furthermore, the assets within the plan are not considered to be those of the beneficiary, so the funds will not significantly harm any applications for financial aid.

One of the serious drawbacks to this type of plan is the limitation placed on its investments. Many of the funds limit investments to only a few choices, which can be restrictive as a hands-on approach to investment management. Another concern is the longevity of these plans. The name of these plans refers to the tax loophole within the IRS code’s section 529, whose existence is only guaranteed until 2010 by Congress. This can create some uncertainty for parents with children who won’t be attending university until well after 2010.

The Bottom Line
The multitude of different savings plans for a child’s education provides a situation that is important to take advantage of. Time is always an asset when trying to save, and tax-sheltered accounts help make sure that any earnings won’t be slowly eaten away by the government. If time is no longer on your side, a 529 account is generally better as it will provide for the maximum tax savings in the shortest duration of time, without affecting your children’s application for financial aid. However, if you don’t want to be limited in your investment decisions and portfolio mix, the 529 plan may not be the best choice. If you have plenty of time before your child graduates from high school, the ESA may be a good choice. If you don’t want to give full control to your children, the UGMA/UTMA accounts may not be the best route. Whatever you decide, make sure you understand the rules of the game before you play.


Top Strategies For Saving In A 529 Plan

Section 529 plans have grown to become one of the most popular ways for students and their families to save for college. Many parents struggle to find the cash to fund these accounts on a regular basis when they are also trying to save for retirement. Fortunately, there are several strategies espoused by college and financial planners that can help those facing this dilemma to sock away the necessary funds for their kids’ futures.

1. Maximize Your Tax Savings

If you’re trying to decide how much to contribute to your plan, try matching it up with the contribution limit for state tax deductions: 33 states and the District of Columbia offer deductions for contributions, and a few of them don’t even require that you contribute to the plan in that state. Kansas offers a maximum deduction of $6,000 for 529 plan donations in any state. Georgia, Mississippi, Oklahoma, Oregon and South Carolina will even let filers take a prior-year deduction for contributions made by the filing deadline. Always check with your state for last-minute changes.

2. Ask for Cash Donations as Gifts

Ask friends and relatives to purchase less expensive items for your children and couple their gifts with small contributions into the plan. Birthdays, holidays and special occasions can combine over time to make a material addition to the account value. E-gifting programs are now available in several states that make it easy for donors to contribute by simply entering their bank account information online and transferring the funds directly into the account. Check to make sure there is no fee involved; programs differ.

3. Donations from the Wealthy

If you are fortunate enough to have friends or relatives who are very well off, consider suggesting a donation into the plan as a way to reduce their taxable estate. One key advantage that 529 Plans offer is the ability to gift an amount equal to five years’ worth of gift-tax exclusions in a single year. For 2014, this means a couple could donate a whopping $140,000 into a single account. Grandparents or other potential donors who have accumulated substantial wealth may also be far more willing to contribute to their grandkids’ futures when they know that the money will be spent on education. Retired donors who have to take mandatory minimum distributions from their retirement plans each year can also funnel this money directly into these plans if they don’t need the income for living expenses.

4. Open a Upromise Account

This nifty program allows families to save by simply registering their credit cards at www.upromise.com and then using the cards to make purchases with online and local retailers. A small percentage of each purchase will then be donated into the plan by the merchant. Fidelity and Upromise also both offer credit cards that pay into 529 plans instead of offering cash back or other traditional rewards.

5. Gamble on Your Kid’s Future

If you play poker or visit casinos on a regular basis, consider donating any winnings you reap into the plan. If you’re lucky enough to win your NCAA basketball tournament pool, this could make a substantial addition to the account.

6. Funnel Contributions Through Yourself

If another donor wants to make a contribution to your child’s plan but won’t be eligible for a state tax deduction, consider requesting that the money be paid first to you so that you can then contribute it if you will receive a deduction. (Of course, be sure to actually make the contribution that is gifted in order to honor the donor’s intention.)

7. Donate Your Tax Refund

If you got a sizeable refund from Uncle Sam this year, consider moving some or all of it into the plan. A $3,000 refund could more than double in 15 years in an account for a young child.

8. Cash In Your Winners

If you made a good stock pick in a retail account and now it’s time to sell, consider moving some or all of the proceeds into the plan. A state tax deduction can help to offset the capital gain that you will have to report.

The Bottom Line

Families who can find creative ways to stretch their college savings dollars further will be ahead of the curve when the tuition bills start to arrive. Other possible savings options include custodial accounts and Coverdell Education Savings Accounts. For more information on college savings, consult your college financial aid officer, high school guidance counselor or financial advisor.


Top Companies That Manage 529 Plans

Among college savings accounts, 529 plans have grown to become one of the most popular types because of their tax advantages and the donor’s ability to retain control of the funds even after the student reaches the age of majority. The days of limited investment choices and high sales charges have largely disappeared from this sector. In addition, more states and plans are offering an expanding array of options with minimal fees and expenses.

Of course, some plans have produced better investment results than others, and some states offer greater state tax benefits to add to the federal ones. All the same, it may not always make sense to use the plan offered by your home state, even if a state deduction is available. Here is a list of some of the top-performing 529 plan providers.

Investment Performance

Savingforcollege.com is one of the best sources for comparing the investment returns posted by 529 plan providers. The site has created an organized ranking system that uses rigorous methodology to break down the various types of plan into seven basic asset-allocation categories, such as equity and short term. Rankings encompass more than 3,000 options from both broker-sold and direct-buy programs.

A subset of portfolios that are identical to each other are selected from each plan and then ranked against each other to get a percentile rating, with lower percentile numbers being better than higher ones. Investment returns are then ranked for 1-, 3-, 5- and 10-year periods. For the second quarter of 2014, the site listed the following top ten plan providers for direct-buy plans, those sold directly to consumers. These are the rankings for 10-year performance:

Rank State Plan Percentile
1 Alaska T. Rowe Price College Savings Plan 22.72
2 Utah Utah Educational Savings Plan (UESP) 23.64
3 Alaska University of Alaska College Savings Plan 23.81
4 Louisiana START Saving Program 36.24
5 New York New York’s 529 College Savings Program — Direct Plan 36.35
6 Kansas Schwab 529 College Savings Plan 37.55
7 Nevada USAA 529 College Savings Plan 38.16
8 Maryland College Savings Plans of Maryland — College Investment Plan 40.24
9 Nevada The Vanguard 529 Savings Plan 40.96
10 Virginia Virginia529 inVEST 42.23

State Tax Deductions

See if your state offers a state tax deduction for contributions up to a certain level in a 529 plan: 33 states and the District of Columbia do. For example, Kansas Learning Quest donors can get a deduction of up to $6,000 per year on their Kansas returns for their contributions. In fact, Kansas, Maine and Pennsylvania do not require residents to contribute to plans in their home state in order to take the deduction.

Some states do not have dollar limits on their contributions, while others allow you to carry excess contributions forward for future deductions (although the amount that can be carried forward varies by state). Some states also impose income limits on donors that prevent those with adjusted gross incomes above a certain level from taking deductions. But this factor should not be the only criteria used to decide which plan is best.

If your state’s plan has poor investment choices and high fees, you will probably be better off forfeiting the state-tax deduction (if there is one) and purchasing a plan elsewhere. Try figuring your tax return with and without the deduction you might get to see what you will actually gain here; a financial planner may be able to help you compare your tax savings to any difference in investment returns to see which is the better choice.

Best in Other Areas

Of course, there are other factors to consider when comparing 529 providers. Kiplinger’s posted a list of providers that stood out in other areas in 2013. Utah’s Educational Savings Plan Trust came in with the lowest investment fees, using a portfolio of Vanguard funds that all charged less than 0.4% per year, plus an annual maintenance fee of up to $20.

The Maryland College Investment Plan was listed as having the best funds in its portfolio with a low-cost mix of offerings from T. Rowe Price.

The Michigan Educational Savings Program was credited with providing the best options for risk-averse investors who don’t want to put their money in stocks. This program contains a guaranteed fund that pays a rate of interest based upon a Treasury note Index. It also offers a portfolio of funds from TIAA-CREF, the custodian of the plan, “tilted more toward bond funds,” Kiplinger’s reports.

The College Savings Plan of Nebraska was chosen as the plan with the best selection of investment choices, containing 20 funds from Pimco, Vanguard, American Century and Fidelity.

Finally, Kiplinger’s ranked the best plan sold by advisers as the Virginia CollegeAmerica Plan. The fees in this plan are a bit higher, but advisers can create portfolios using 22 American Funds.

Kiplinger’s also listed its choice of the best 529 provider in each state, with a rationale for each and a discussion of that state’s tax or other regulations. For example, it selected the direct-sold version of the Higher Education 529 Fund as the best choice for Alabama because of its lower fees and tax advantages.

NerdWallet’s review listed TD Ameritrade as the best 529 Plan sponsor for donors who were not eligible for any type of state tax deduction in 2013. The company offers a wide range of investment options, including many for sophisticated investors, along with a rebalancing portfolio that becomes more conservative as the child nears college age. It has low fees and award-winning customer service, as well as a user-friendly online platform.

The Bottom Line

The 529 Plan market will likely continue to grow and become more competitive for the foreseeable future. The best plan for you will depend on your state tax rules, your risk tolerance and time horizon, and the amount of professional assistance you require.


Top 7 Mistakes To Avoid On Your 529 Plan

Investing in your child’s education is one of the most important things you can do for your child. A 529 plan enables you to start saving early – the earlier the better – so you can allow the money you invest to make more money for you and your child. But, there are some pitfalls you must avoid if you want that investment to pay off when your child is ready to go to school. We look at the top seven mistakes that could trip you up.

1. Not Considering Your State Plan First

The biggest mistake you can make is picking the wrong plan. As you begin your research start with your state plan first to understand what it offers. Every state offers at least one 529 plan, but they are not all created equally. One of the biggest advantages is that your contributions in more than 30 states can result in a tax credit to lower your annual state bill.

If you live in one of these five states – Pennsylvania, Arizona, Maine, Kansas or Missouri – you can invest in any state’s plan and still reap the tax benefits they offer.

Even if your state offers tax benefits, be sure the investment options match the types of investment choices you want to make. A good place to start comparing 529 options on the internet is SavingforCollege.com and its ranking of the top performing funds.

2. Failing to Understand Your State’s Guarantee

Some states offer prepaid tuition plans, but not all tuition guarantees are the same. Some states offer you the opportunity to lock in tuition fees provided your child chooses to go to an in-state school. But beware, many states that make this guarantee don’t guarantee your returns. If your returns fall short, there may not be enough money even at the guaranteed tuition rate.

If a tuition guarantee is important to you, the only states you can count on are: Florida, Massachusetts, Mississippi or Washington. Otherwise there is no guarantee if tuition growth outpaces the growth of your investments. Be sure to read the fine print.

3. Disregarding Fees and Expenses

As with any investment, fees and expenses can have a negative impact on the success of your investment. Research done by the Financial Research Corporation, a major mutual fund research organization, found that the average annual fee for a 529 is 0.69%, if purchased directly from a state. But 529s purchased through brokers average 1.17%.

That difference in fees can really add up over time. If you invest $10,000 on the day your child is born, it will be worth $39,246 on his or her 18th birthday if you assume an 8% return with 0.1% internal fees. If those fees are 1.1%, the same 8% return will only grow to $32,746. “That’s free money you’re just leaving on the table that could be spent on your child’s education,” says Brian Preston, a CFP for Preston & Cleveland Wealth Management in McDonough, Ga., and host of the Money Guy.

4. Paying Avoidable Penalties to Switch Plans

If you start out in a 529 and find you’ve made a mistake, you can switch plans, but do so very carefully to avoid penalties and taxes. You can only make one penalty-free rollover into a new 529 in any 12-month period. The only exception to this rule is if you want to change the family member who will benefit from the plan. For example, suppose you started a 529 for each child at birth. One of your children won a full scholarship and won’t need the money. You can roll over the funds into the name of another child without worrying about the once-in-12-months rule.

The best way to avoid any risk of penalty or taxes is to work with the new plan administrator to coordinate the transfer. There are other fees you must watch out for, too: Some states have a recapture tax on past tax deductions if you do an out-of-state rollover. Others charge fees to provide rollover services. So be sure you ask about all possible fees if you are thinking of changing 529 plans.

5. Withdrawing Funds Incorrectly

When you’re ready to start using the funds for your child’s education be careful how you withdraw those funds. The money can only be spent on qualified higher education expenses (QHEE).

If you don’t follow the rules, you can face unnecessary taxes and penalties. Here are two key things to consider:

– If you pull out money before your child enrolls in college you will pay taxes on the money, including an additional 10% penalty on the portion that constitutes earnings (not your original deposit). So don’t remove the money before your child enrolls and then only take out what is needed to cover the child’s QHEE.

– Be sure to consider all grants and scholarships when calculating how much money you can take out in any one year. You must subtract money your child receives from other sources before taking out 529 funds. If you take out too much, the excess will be considered taxable income and you will have to pay that additional 10% penalty on the earnings portion of the money.

If your child doesn’t need the money, thanks to scholarships and grants, you can transfer the funds to another family member without taxes or penalties – or save it in the fund for the child’s future use, such as graduate school.

6. Covering Non-qualified Expenses

Some college costs are not qualified expenses for 529 money. For example, you can’t pay off student loans or pay transportation costs with the funds. If your child wants to live off campus, ask your college for room-and-board expenses that would be typical if they lived on campus. You can only use 529 money towards off-campus housing that does not exceed the on-campus costs.

7. Delaying Your Contributions

As with any investment, delaying your contributions is always a big mistake. For example, $1,000 deposited when your child is born will grow to $3,996 in 18 years at an interest rate of 8%. Wait until your child is 10 and that $1,000 has only eight years to grow and will amount to just $1,850 by the time your child is ready for college.

The Bottom Line

Start saving for college as soon as your child is born. You, as well as other family members, such as grandparents, can make contributions to the 529. Carefully research your options, but if you make a mistake you can switch plans at a later date.


529 Plans: Introduction

529 Plans: Introduction

529 plans (also known as a “qualified tuition program”) were created under the Small Business Job Protection Act of 1996 (SBA ’96) as a means of allowing taxpayers to save for higher education expenses for a designated beneficiary. A 529 plan may be provided by a state, an agency of the state or by an educational institution.

Like the education savings account (ESA), the 529 plan is an excellent way to save for education expenses. Earnings accumulate on a tax-deferred basis and distributions that are used for qualified education expenses are tax- and penalty-free. Unlike the ESA, the 529 plan may be set up in a way that allows individuals to prepay a student’s qualified higher-education expenses at an eligible educational institution. Also, the contribution limits for a 529 plan are considerably higher than those for an ESA. Here we take a look at 529 plans, how they work and how you can use them to save for a child or grand-child’s college education.


529 Plans: Types Of Plans

There are two types of 529 plans:

  • Prepaid tuition programs, which may be offered by the state of an eligible educational institution. Prepaid tuition programs allow for the advance purchase of credits for the designated beneficiary. These are usually established during enrollment periods established by the state of the eligible educational institution.
  • College savings plans allow contributions to be made to the account on behalf of the designated beneficiary. These can usually be established at any time, including immediately after the designated beneficiary is born.

Individuals would review the feature and benefits of both types of 529 plans to determine which is more suitable for the designated beneficiary.

The designated beneficiaryunder a 529 plan is the student the plan is established for. The designated beneficiary can be changed to an eligible person. Typically, the designated beneficiary is changed if the current designated beneficiary will not need the funds in the 529 plan for eligible education expenses. If a state or local government or certain tax-exempt organizations purchase an interest in a 529 plan as part of a scholarship program, the designated beneficiary is the person who receives the interest as a scholarship.

For purposes of a 529 plan, an eligible educational institution is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education. This includes virtually all accredited public, nonprofit and proprietary (privately owned profit-making) post-secondary institutions.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education’s Federal Student Aid (FSA) programs.

Individuals should check with the educational institution to determine if it is an eligible education institution for 529 plan purposes.