What Is a 529 Plan? Should You Use One?

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With the high costs of college, parents are looking to start planning early for their children's education. 529 college savings plans allow you to do just that and have become a popular way for parents to build savings for future education expenses. You can contribute to investment portfolios to build your money over time or purchase credits at certain schools, depending on the plan you choose. Read to learn more about these plans and explore your state's 529 plan options.

What Is a 529 College Savings Plan?

A 529 plan is a tax-advantaged savings plan, sponsored by states, state agencies or educational institutions, intended to help people put away money for future education costs. There are two types of 529 plans to choose from: education savings plans and prepaid tuition plans. You use after-tax dollars to contribute and don't pay federal taxes on your gains. Also, your withdrawals may be tax-exempt, usually as long as you use the funds for qualifying higher education expenses.

Every state, besides Wyoming, sponsors at least one of these plans, and you are even able to choose other state's plans to contribute to, based on the plan's requirements. Some require residency in the state, while others allow a few or all state residents to contribute to their plans. And because you are not limited to your state's plan(s), you should explore your options to find which works best for you. Below, we take a look at the types of plans you can choose from.

Education Savings Plans

Education savings plans allow you to open a college investment account to save for your beneficiary's future education expenses, which can include tuition, fees, and room and board. You can choose from a variety of investment portfolio options, often including mutual funds and exchange-traded fund (ETF) portfolios, and a principal-protected bank account. There are direct-sold and adviser-sold plans within this type of plan. Keep in mind that going through an adviser will cost more, as they generally require fees.

On top of college costs, withdrawals from this account can also be used to pay up to $10,000 per year per beneficiary for tuition at public, private or religious elementary or secondary schools. As with any investment, you may make money or lose the money vested. All education savings plans are sponsored by state government, but they do not guarantee investments in these plans. Also, only a few states have residency requirements. The federal government does not guarantee mutual funds and ETFs, but some principal-protected bank products are insured by the FDIC.

Prepaid Tuition Plans

Prepaid tuition plans let you or the account holder purchase units or credits at participating colleges and universities, generally public and in-state, for future tuition and fees at current prices for your beneficiary. Generally, these plans can be used to pay for tuition and fees but cannot be used to pay for future room and board costs or to prepay for tuition at elementary or secondary schools.

Most of these plans are sponsored by state governments but are not guaranteed by the federal government, and have residency requirements. If your plan's sponsor has a financial issue and your prepaid payments aren't guaranteed, you might lose some or all of your money in the plan. Also, if a beneficiary doesn't attend one of the participating colleges or universities, you will likely receive less than you would have if they did attend one of those schools.

Should You Use a 529 College Savings Plan?

529 college saving plans are a great way to save for future education expenses, especially since the average costs of college are so high. However, there are still some downsides to using these plans, as you have less say over your investments and you are banking on the fact that your child will need this money later on. Here are some of the pros and cons of 529 plans to consider.

Pros of 529 Plans

529 plans have tax benefits: As long as the 529 funds are used for your beneficiary's qualifying educations costs, you likely won't have to pay tax on the withdrawal of the funds. This benefit is available to all taxpayers and is not dependent on income. Also, when you invest in a 529 savings plan, you don't have to pay federal taxes on the growth of your contributions and many states offer tax-benefits for in-state contributors.

You can switch beneficiaries: In the chance that your child skips college, doesn't use all of the funds or doesn't need the funds, you can change the beneficiary of your 529 savings plan to another family member. Generally, you can change the beneficiary without being taxed or penalized and there is no deadline for when the 529 funds must be used. This is a helpful benefit as not using the money for education costs has a penalty.

You can use another state's 529 plans: You are able to use the 529 plans from other states if you prefer a different plan from what your state offers. However, a few states have residency requirements for you and/or your beneficiary, meaning that you may have to live in the state for a certain amount of time to qualify. If you don't fit one state's requirements, there are plenty of other states to choose from.

Cons of 529 Plans

It could reduce your child's need-based aid: When your beneficiary applies for financial aid through the Free Application for Federal Student Aid (FAFSA), your family's finances are considered. This means that your 529 savings may be considered and could increase your beneficiary's Expected Family Contribution (EFC), which is used to calculate eligibility and the amount of aid your beneficiary will receive.

There are penalties for noneducational withdrawals: If you withdraw you 529 funds for ineligible expenses, the earnings are taxable by the federal government and your state, in addition to a 10% penalty. If you want to avoid this, be sure to go through what expenses qualify, try not to withdraw more than you need, and keep a record of your expenditures.

There are limited investment options: When you open a 529 plan, you are limited to the investment options within the plan. You must choose from preset investment options, and you'll be limited to how many times you can change where your payments are allocated. If you want different investment options than what is offered, your only option is to switch plans. You can only change plans once every 12 months or you risk a 10% fee and tax bill.

Which States Offer 529 College Savings Plans?

All states and the District of Columbia, besides Wyoming, sponsor at least one 529 savings plan. The tax benefits, minimum contributions and requirements will vary by state. Below we've listed all the 529 plans each state offers and we recommend that you explore options from different states as they may have better benefits for you. Some plans have multiple account options to choose from, including adviser-sold plans.

StateEducation savings plan(s)Prepaid tuition plan(s)In-state tax benefit option
AlaskaNo state planNo
ArizonaNo state planYes

ArkansasNo state planYes

CaliforniaNo state planNo
No state planYes
ConnecticutNo state planYes
DelawareNo state planNo
District of ColumbiaNo state planYes
GeorgiaNo state planYes
HawaiiNo state planNo
IdahoNo state planYes
IndianaNo state planYes
IowaNo state planYes
KansasNo state planYes
LouisianaNo state planYes
MaineNo state planNo
MinnesotaNo state planYes
MissouriNo state planYes
MontanaNo state planYes
NebraskaNo state planNo
New HampshireNo state planNo
New JerseyNo state planNo
New MexicoNo state planYes
New YorkNo state planYes
North CarolinaNo state planYes
North DakotaNo state planYes
OhioNo state planYes
OklahomaNo state planYes
OregonNo state planYes
PennsylvaniaNo state planYes
Rhode IslandNo state planYes
South CarolinaYes
South DakotaNo state planNo
TennesseeNo state planNo
UtahNo state planYes
VermontNo state planYes
West VirginiaYes
WisconsinNo state planYes
WyomingNo state planNo state planN/A

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