529 Plans Defined: What’s the difference?

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College tuition keep rising and there’s no end in sight.  Can you afford to send your kids?

If you’ve asked yourself that question, you’re probably looking in the wrong direction.  The honest truth is that we’ve built a knowledge economy, in which success is predicated on a good education.  This is why we each spend the better part of our first 25 years going to one school or another.  And in this new reality, you can’t afford to not send your kids to college.

To help prepare you for this inevitable expense the government created tax and inflation efficient 529 plans.  But what are they and which type should you choose?

Here is a quick explanation by the Securities and Exchange Commission (SEC):

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

There are two types of 529 plans: college savings plans and pre-paid tuition plans. All fifty states and the District of Columbia sponsor at least one type of 529 savings plan. In addition, many colleges and universities sponsor pre-paid tuition plans.

Essentially, the former is a savings account towards any college and the latter is a downpayment toward a specific school or group of schools.  The following chart outlines some of the other differences:

Prepaid Tuition Plan College Savings Plan
Locks in tuition prices at eligible public & private colleges and universities. No lock on college costs.
All plans cover tuition & mandatory fees only. Some plans allow you to purchase a room & board option or use excess tuition credits for other qualified expenses. Covers all “qualified higher education expenses,” including:

  • Tuition
  • Room & board
  • Mandatory fees
  • Books, computers (if required)
Most plans set lump sum and installment payments prior to purchase based on age of beneficiary and number of years of college tuition purchased. Many plans have contribution limits in excess of $200,000.
Many state plans guaranteed or backed by state. No state guarantee. Most investment options are subject to market risk. Your investment may make no profit or even decline in value.
Most plans have age/grade limit for beneficiary. No age limits. Open to adults and children.
Most state plans require either owner or beneficiary of plan to be a state resident. No residency requirement. However, nonresidents may only be able to purchase some plans through financial advisers or brokers.
Most plans have limited enrollment period. Enrollment open all year.

This is the first of three posts about 529 plans.  In the coming days, I’ll delve more deeply into each type of plan so you can know how to make the most of each.

Read more about Choosing the best 529 Savings Plan here

Read more about 529 Prepaid Tuition plans here