529 Plans and The Cost of College: How Might These Work for You?

The subject of 529 plans for college savings, and their tax advantages, have been in the news lately, as the Obama Administration floated the idea of taxing these plans as a way of helping to pay for taxpayer-paid (and in that respect, “free”) community college for students across America.

That proposal quickly died because of an immediate outburst across America from Republicans, Democrats, and parents, as the New York Times reported on Jan. 27:

“The decision came just hours after Speaker John A. Boehner of Ohio demanded that the proposal be withdrawn from the president’s budget, due out Monday, ‘for the sake of middle-class families.’ But the call for the White House to relent also came from top Democrats, including Representatives Nancy Pelosi of California, the minority leader, and Chris Van Hollen of Maryland, the ranking member of the Budget Committee.”

Thus, 529 plans are safe – for the moment, anyway – from threats of taxation. But as the controversy bubbled into the news, a good many Americans were undoubtedly wondering, “What exactly are they talking about?”

A 529 plan is so-named because it exists under Section 529 of the Internal Revenue Code. According to MarketWatch, as of Sept. 2014, Americans had more than $240 billion in the two types of 529 plans, pre-paid tuition and college savings.

Essentially, the two plans do the following:

  • Pre-paid tuition plans: you buy tuition “credits” for public college or university at today’s prices and your child can attend an in-state school for as many hours, semesters, or quarters you purchased, regardless of the prices when your child heads off to school.

These plans are a bit pricier than the college savings plans, for the obvious reason that college is likely to be more expensive at the time your child begins matriculating. That’s a reason why pre-paid plans may not accept young children, for the same reason.

  • College savings plans: these enable college-saving families to put money into investment vehicles, such as stock, money market, and bond funds. These are pre-selected fund groupings, and the fund managers make investments for the investors, or account holders.

The two plans have attributes to make them attractive to different types of savers. For example, the pre-paid plans may be backed by state governments while college savings plans are neither backed nor insured.

But basic pre-paid plans are limited in what they cover, while college savings plans pay for a greater number of expenses.

Adding to the attractiveness – and perhaps the key reason – for the popularity of 529 plans is that they come with tax advantages. For example, as money in these plans grows, it does so tax-free. If used for qualified higher education expenses, there is no tax on the money as it’s drawn for use. There are a number of other variations on this theme with respect to 529 plans.

For example, Indiana residents receive a 20% tax credit on the first $5,000 put into an Indiana-sponsored 529 plan.

There are many variations and features to each of these plans. If there’s a child for whom you’d like to set aside money for college, give 529 plans a good look. You may find something you like that will ease your student’s financial, and potentially debt, burden.

You can view the Securities and Exchange Commission’s primer on 529 plans here.

Tagged 529 Plan, Accounting, Featured, IRS, College