529 plan
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A 529 plan is a savings plan in the United States designed to give tax advantages to encourage saving for future higher education expenses. It is named after section 529 of the Internal Revenue Code. 529 plans are run by state boards or the organizations they delegate the administration of the plan to. Most plans have at least a few options for how the contributed funds are invested, though currently the law does not allow investing in a choice of mutual funds, but instead only a few general investment options. Usually a fixed account that offers a relatively low, but guaranteed return is offered along with various options combining equities (stock) and/or bonds. Often an age weighted investment option is offered that gradually and automatically moves the investment mix to a more conservative mix as the child approaches higher education age.
With the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), 529 plans gained their current prominence, flexibility, and tax advantages. Previously plans falling under section 529 were limited to state pre-paid tuition plans. After EGTRRA, distributions from 529 plans for qualified higher education expenses at a qualified institution are exempt from income tax. The act also allowed the creation plans with a number of investment options, funded by guaranteed accounts and stock or bond mutual fund like options.
Advantages
- All money grows federal and state income-tax free
- All distributions for qualified higher education expenses are federal income-tax free (federal tax-free withdrawals expire 12/31/10 unless extended by Congress)
- Many states also exempt withdrawals from state income-tax for qualified higher education expenses
- Money can be used virtually everywhere -- over 8,000 schools in the U.S. and over 800 foreign schools
- Money can be used to pay for tuition, room, board, books, fees, supplies and required equipment
- The beneficiary can be changed at any time
- High maximum contribution limits
- Powerful estate planning advantages -- account owners can contribute up to $55,000 per beneficiary or $110,000 (married filing jointly) immediately as long as they don't make additional contributions until 5 years has passed
The income tax advantages have contributed significantly to their popularity as a college savings tool.