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529 Plan

A tax-advantaged savings plan that promotes saving for future higher education expenses

What is a 529 Plan?

A 529 plan is a savings plan that offers tax advantages and supports the idea of saving for higher education expenses in the future. States, state agencies, or educational institutions sponsor 529 plans, also called “qualified tuition plans.” A designated beneficiary must be attached to the plan.

 

529 Plan

 

The savings plan got its name from Internal Revenue Code 26 U.S.C. § 529. The passage of the Tax Cuts and Jobs Act (TCJA) in 2017 added more benefits to the plan. The act allows private and religious school tuitions – as well as post-secondary education costs – to qualify for the savings plan.

 

Summary: 

  • The 529 plan is a savings plan that offers with tax benefits and encourages individuals to save for future higher education costs.
  • Investors both in and out of the beneficiary’s state of residence can invest in a 529 plan; there are more benefits for in-state investors.
  • There are two types of 529 plans: (1) College savings plans and (2) Prepaid tuition plans.

 

Types of 529 Plans

 

1. College savings plans

Savings plans differ from prepaid plans because the former’s growth is determined entirely by how well its underlying investments are doing. Most of the underlying investments with a 529 savings plan consist of mutual funds. Savings plans also come with a variety of age-based asset placement options. It means that the underlying investments grow more conservatively as the beneficiary draws closer to the age where they will be attending college.

Only states can hand out savings plans. Administrative services, however, are typically handed over to a mutual fund company or other financial service business.

 

2. Prepaid plans

Prepaid plans are, as mentioned above, different from savings plans. A 529 prepaid plan allows for the purchase of tuition credits at existing rates. The credits accrue and are saved to be used in the future. They also differ in the fact that both states and higher education institutions can offer the plans. As of 2019, there are only ten states that offer prepaid plans. They are:

  • Florida
  • Illinois
  • Maryland
  • Massachusetts
  • Michigan
  • Nevada
  • Pennsylvania
  • Texas
  • Virginia
  • Washington

 

History of 529 Plans

The very first 529 plan was established in 1986. It was a prepaid tuition plan that the Michigan Education Trust (MET) created.

However, it was the Internal Revenue Code 26 U.S.C. § 529, added in 1996, that helped popularize the plan across the country. It established a tax-free status for tuition programs that qualified. All 529 plans generate earnings that accumulate tax-free. Distributions from the plan can’t be federally taxed when they are used to cover educational expenses from qualified higher learning institutions. (The plan generally doesn’t discriminate against most colleges and can be used for institutions outside of the state of residence.)

In 2015 the term “higher education expenses” was broadened to include computers as a qualified expense. Then, in 2017, it was expanded further to allow for up to $10,000 yearly for tuition for K-12 schools.

 

In-State vs Out-of-State Investing

Investors from a state who is not where the beneficiary resides can invest in a 529 plan, according to the guidelines that dictate the rules for the plan.

It is, however, more advantageous for investors living in the state of the beneficiary’s residence, as there are serious state tax advantages. There are other benefits as well, which include:

  • Investors being exempt from state financial aid calculations
  • Protection against creditors asking for payments
  • The matching of grants and scholarships

 

Additional Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • American Opportunity Tax Credit (AOTC)
  • FUTA Tax
  • Social Security
  • Tax Deductible

Financial Analyst Certification

Become a certified Financial Modeling and Valuation Analyst (FMVA)® by completing CFI’s online financial modeling classes and training program!