A 529 College Savings Plan, as codified in the United States Tax Code, are college savings plans that parents of potential college students may invest in order to save money for their child’s college tuition. 529 College Savings Plans permit parents to deduct the money invested in 529 College Savings Plans to qualify for State tax deduction, effectively lowering their taxable income.
There are two types of 529 College Savings Plans: prepaid and savings. Prepaid 529 College Savings Plans allow parents to purchase tuition credits at present day rates. This essentially means that a parent who will have a child in college in 20 years may place money in a Prepaid 529 College Savings Plan, at the current rate of tuition, to be used 20 years from that date, even if tuition is higher in the future. For example, if the current per credit tuition is $2,000 and the parent purchases 5 credits through the Prepaid 529 College Savings Plan then it will guarantee those 5 credits even if the per credit tuition rate is $4,000 by the time the child goes to college.
The other type of 529 College Savings Plan is different in that the growth of the Savings 529 College Savings Plan is based on market performance of the investment form, which is usually in the form of mutual funds. In this way you may benefit greatly over a Preferred 529 College Savings Plan in that the market could outperform the rate of tuition increase. However, in the alternative, the Savings 529 College Savings Plan may have stagnant, or negative growth, over time that would not equal or exceed the Prepaid 529 College Savings Plan.
A 529 College Savings Plan may be used for tuition, books, fees, equipment and supplies for any accredited college or university, public or private, in the United States as well as vocational schools and some universities from outside the United States. 529 College Savings Plans may also be used for room and board. However, if the student lives off campus the student may only use the 529 College Savings Plan for expenses that would be equivalent to the cost of on campus room and board. For example, if the cost of room and board on campus is $6,000 and the student lives in off campus housing costing $8,000 then the 529 College Savings Plan will only cover $6,000 of that.
One of the great advantages of a 529 College Savings Plan is that it affords tax exemption from state taxes. This means that all the money that is contributed into the 529 College Savings Plan will be treated as if the money was never considered part of your income. For example, if your income for the year is $100,000 and you contribute $10,000 to your 529 College Savings Plan in that year then, for tax purposes, you will be treated as if your income for the year was $90,000. 529 College Savings Plans are considered to be a great way to avoid estate taxes in that they are not considered part of you estate, but part of the estate of your child, however, they are not irrevocable. This means that any unused portion of the 529 College Savings Plan may be taken out of the 529 College Savings plan and reinvested by the parent. Even though it is perfectly legal to do this the parent will be required to pay income tax on the benefit incurred as well as a 10% early withdrawal penalty.
The exception to the early withdrawal penalties are: the designated beneficiary dies; the designated beneficiary becomes disabled; or the designated beneficiary receives a scholarship, veterans assistance, or employer provided education assistance. If one of these things occurs then the penalties will not apply. Even if none of these exceptions apply no penalty will be incurred by the 529 College Savings Plan holder if, for some reason, the entire allotment of savings is not used on the named beneficiary and the amount remaining is rolled over to another beneficiary. If the leftover amount of the 529 College Savings Plan is rolled over to another qualified recipient within 60 days then the there will be no penalty associated with early withdrawal.