529 Plans Frequently Asked Questions

What are the tax benefits?

Can I claim a federal income tax deduction based on my contributions into a Section 529 state college savings plan?

Can I claim a state income tax deduction based on my contributions into a Section 529 state college savings plan?

Are withdrawals from a Section 529 state college savings plan exempt from federal income tax?

Are withdrawals from a Section 529 state college savings plan exempt from state income tax?

Can my investment in a qualified state tuition program be used throughout the U.S.?

What if my child does not attend college?

What if my child receives a scholarship?

How can I change the beneficiary on an account?

Is investment in qualified state tuition programs recommended by financial advisors?

Are there restrictions regarding a qualified state tuition program and Education IRAs?

Can funds be used for more than just tuition costs?

Do 529 plans guarantee college admission for my child?

How will participating in a qualified state tuition program affect financial aid eligibility?

How much will college cost when my kids are ready to go?
College costs are rising! According to the U.S. Department of Education, the average cost of a four-year education at a public university is currently $34,000, and almost $90,000 for private colleges. Over the past decade, expenses at public institutions have increased nearly 40%, and costs will almost certainly continue to rise.

Estimating future college costs can be difficult! Many factors must be considered, including public vs. private colleges, in-state or out-of-state, will the student live at home or in another residence. One thing is for sure, tuition rates have been increasing at more than twice the rate of inflation for over thirty years and will continue to rise in the future.

You should consider college an investment for the future. Data from the U.S. Census Bureau indicates that a person with a bachelor's degree earns on average over 80 percent more than a person with only a high school diploma. The sacrifices you make to save for your college education today, pays off in an increased earnings potential in the future.

Most 529 plans have “college cost calculators” that can help you determine how much you need to save to meet your college savings goals.

What is a 529 Plan?
A Section 529 state college savings plan is a special state administered college savings program that adheres to various federal laws and the Internal Revenue Code Section 529. These plans allow investors to save money in a special account in which the earnings will grow income tax deferred and when used to pay for "qualified higher education expenses" will be federal income tax-free. In many states, a participant can receive special state incentives, including tax deductions and exemptions, based on their participation in the in-state program(s).

What’s the difference between a prepaid tuition program and a savings / investment program?
Prepaid Tuition: Essentially, parents, grandparents, and other interested parties may purchase future tuition at a lower rate today then the program will pay the future college tuition of the beneficiary at any of the state’s eligible colleges or universities (or an equal payment to private and out-of-state institutions). Amounts of tuition (years or units) may be purchased through a one-time lump sum purchase or monthly installment payments. The program pools the money and makes long-range investments so that the earnings meet or exceed college tuition increases in that state.

Savings / investment Plans : Savings / investment plans allow participants to save money in a special college savings account on behalf of a designated beneficiary’s qualified higher education expenses. Contributions can vary, depending on the individual savings goals. The plans offer a variable rate of return although some programs guarantee a minimum rate of return.

Which type of plan is better?
It depends upon the investment needs and goals of the family. Each state has created innovative college savings programs individually designed to reflect the unique needs of its citizens. The plans represent affordable, flexible, and tax-advantaged options that can ensure the education of our most precious resources - the children of America. Some states are starting to offer their citizens both types of programs, giving families the option to choose the college savings vehicle that is right for them.

Who can be a beneficiary?
Anyone can be named a beneficiary of an account regardless of their relationship to the person who establishes the account. You can even establish an account with yourself as the named beneficiary. The only requirement is that the beneficiary must be a US citizen or a resident alien.

Who can open an account?
Generally, anyone can establish a Section 529 savings / investment plans for any other person, even for him or herself. This allows a person to save for their continued education in graduate school or professional school later in life. It’s not just a child’s future education. You should consult the individual state program(s) to determine specific eligibility requirements that may apply.

Do 529 savings / investment plans have income limitations?
There are no income limitations on a person’s ability to contribute to an account other than the life-time maximums each state designate for its program.

Can an account owner withdraw the money without paying for college costs?
Yes, the account owner can withdraw all the funds in an account at any time. However, this will be classified as a “non-qualified withdrawal” and will result in the account owner owing income taxes on the earnings on the account and an additional 10% penalty for withdrawing the money and not using them for qualified higher education expenses.

Once an account is established, who controls the investments?
Each state has developed a program designed for the benefit of its residents. Many states have chosen to contract with an investment manager to work with the state to develop investment portfolios and options that will help investors meet their college savings needs. Federal law prohibits the investor from having direct control over the selection of specific investments; therefore the state and the investment manager typically offer a large number of savings options for the investor to choose from, when they open an account.

Who can contribute to an account?
Generally, anyone can make a contribution to an account for any beneficiary. However, you should contact the program of your choice to determine the specific rules that apply, you may find that you will be eligible for specific state tax incentives by being recognized as the account owner.

What are the most common investment options offered by Section 529 savings / investment plans?
The most common investment option is the age-based allocation strategy, a strategy in which the age of the beneficiary and his / her year of matriculation determine the specific mix of investments. As the child ages, the investment mix becomes less risky, increasing the likelihood that the money that has been saved will be available when it is needed.

There are many other options available, including 100% equity funds, fixed income funds, stable value funds, as well as a variety of equity and fixed income options within many plans.

Can you change investment options once you have opened an account?
According to federal law, the investment option chosen for an account can be changed one time each year. However, each time a new contribution is made to an account, the investor can select a different investment option for the new contribution into the plan.

Can a savings / investment account be rolled over to another 529 program?
Generally rollovers are allowed. For instance, if the beneficiary of the account decides not to attend a post-secondary institution, the account owner can typically transfer funds in the account to another eligible beneficiary. To avoid penalty and income tax, the new beneficiary must be a member of the family of the original beneficiary. Additionally, you should check with the program you participate in to determine if there are other requirements that may apply.

Who controls a prepaid tuition account?
The account purchaser maintains control over all of the money in the account and is the only one who can request account changes or refunds. The student beneficiary does not have any control over the account, unless he or she is also the designated purchaser.

Does the account owner have to be related to the beneficiary?
No. In most states, you can open an account for your child, grandchild, nephew, friend – even yourself. Review the program materials for naming and changing the designated student beneficiary.

Can more than one person make contributions to a prepaid tuition account?
Yes. Generally, anyone can contribute to an account. Prepaying tuition is an excellent gift idea for grandparents, other family members and friends. You should contact the program in your state to determine the specific process to follow to make additional contributions to the account.

Can prepaid tuition plans only be used at in-state schools?
Prepaid tuition plan benefits are generally designed to be used at in-state public universities and community colleges, however they can also be used at most private institutions and at out-of-state public and private colleges and universities. These programs can be used at most institutions eligible to receive federal financial aid including many colleges and universities located outside the United States.

What happens to my prepaid tuition plan if my child receives a full or partial scholarship?
If the scholarship covers some or all of the student's tuition and fees, the unused prepaid tuition benefits can be transferred to another member of the family, held for possible future use, or a refund can be paid to the purchaser on a semester-by-semester basis.

What if my child decides not to attend college?
Refund and transfer options are available. You should check with the program to determine who the benefits can be transferred to or how to receive a refund from the account.

Does a prepaid tuition account guarantee college admission or in-state tuition?
No. Having a prepaid tuition account does not affect your child’s chances of getting in to a particular college or your eligibility for in-state tuition rates.

Can a prepaid tuition account be rolled over to another 529 program?
Generally rollovers are allowed. For instance, if the beneficiary of the account decides not to attend a post-secondary institution, the account owner can typically transfer funds in the account to another eligible beneficiary. To avoid penalty and income tax, the new beneficiary must be a member of the family of the original beneficiary. Additionally, you should check with the program you participate in to determine if there are other requirements that may apply.

What are the tax benefits?
Both types of programs are "qualified tuition programs" under Internal Revenue Code Section 529 (26 U.S.C. 529). This federal law allows earnings to be federally tax exempt beginning January 1, 2002. Additionally, most states exempt earnings from state income tax, and some states allow families to deduct the full or a partial amount of their contribution from their state income taxes.

When your dependent son or daughter uses their Section 529 state college savings plan account for college, and your family meets household income requirements, you can claim the new Hope tax credit on your tax return (up to $1,500 each year for the first two years of college; up to $1,000 in Lifelong Learning credits can be claimed in subsequent years). Hope credits can only be claimed against payments for tuition and related expenses (not room and board) and there is an income limitation for eligibility of $40--50,000 for individuals and $80--100,000 for couples filing jointly.

Can I claim a federal income tax deduction based on my contributions into a Section 529 state college savings plan?
Unfortunately, there is not a federal income tax deduction for contributions into a Section 529 state college savings plan.

Can I claim a state income tax deduction based on my contributions into a Section 529 state college savings plan?
Many states offer residents a deduction on personal income tax returns for contributions made to the in-state program. As a general rule, you should contact the program in your state to determine the specific state tax rules that apply to investing in a Section 529 state college savings plan.

Are withdrawals from a Section 529 state college savings plan exempt from federal income tax?
As long as the withdrawal is used to pay "qualified higher education expenses", it is exempt from federal income tax.

Are withdrawals from a Section 529 state college savings plan exempt from state income tax?
Most states allow residents to participate in the 529 plans and to receive a state income tax exemption for all “qualified withdrawals”. Several states do not have an income tax, therefore they do not tax distributions from 529 plans. As a general rule, you should contact the program in your state to determine the specific state tax rules that apply to investing in a Section 529 state college savings plan.

Can my investment in a qualified state tuition program be used throughout the U.S.?
Generally, prepaid tuition and savings / investment plan accounts can be used nationwide at any post-secondary school that is eligible to participate in federal financial aid programs. Click HERE to access the U.S. Department of Education’s database.

As a general rule, you should contact the program in your state to determine which colleges and universities are eligible to receive distributions from your state’s Section 529 plans.

What if my child does not attend college?
You may choose to hold the investment in the qualified state tuition program until a later date when the beneficiary may decide to attend college, or you may transfer the account to another member of the beneficiary's family. You may also request a refund, and the account will be refunded according to the program’s policy. By federal law, the earnings portion of all non-qualified distributions is taxable as ordinary income and will be subject to an additional federal excise tax of 10 percent of the earnings, except in the case of the student's death, disability, or receipt of a scholarship.

What if my child receives a scholarship?
If your child receives a scholarship that covers the cost of qualified expenses, a refund can be made up to the amount of the scholarship without incurring the additional federal excise tax of 10 percent (although income taxes are payable on the earnings portion of the refund). Funds can also be transferred to another family member, or they can remain in the account for future use.

How can I change the beneficiary on an account?
Each program can provide the forms necessary for changing the beneficiary on an account. Contact your program to determine the specific requirement and forms necessary to complete this procedure. Depending on the relationship of the new and old beneficiaries, changing the beneficiary of an account may trigger a taxable event, which could also include a penalty, gift tax or both.

Is investment in qualified state tuition programs recommended by financial advisors?
Many financial planners, tax accountants, and other financial advisors support state plans and recommend them to their clients as a program that may fit their college planning needs. In fact, national investment firms have partnered with various states to introduce college savings plans.

Are there restrictions regarding a qualified state tuition program and Education IRAs?
Beginning in January 2002, individuals can contribute to both 529 plans and Education IRAs. The Economic Growth and Tax Relief Reconciliation Act of 2001 permits contributions to the Education IRA (now called Coverdell Education Savings Account) to cover K-12 education expenses on a tax favored basis. Individuals may benefit by funding a 529 plan for the child's college and utilizing the Education IRA for elementary and secondary education expenses.

Can funds be used for more than just tuition costs?
Yes. While policies will vary by state, most states allow for funds to be used for any qualified higher education expense such as tuition, fees, room and board, books, supplies, and equipment required for enrollment.

Do 529 plans guarantee college admission for my child?
Your child will still be required to meet entry requirements as determined by individual colleges or universities.

How will participating in a qualified state tuition program affect financial aid eligibility?
Any investment may impact a student's eligibility for need-based financial aid. Financial aid treatment of investments has changed through the years so it is impossible to know how assets will be treated in the future. Current financial aid formulas only include about five percent of parental assets (any investment a parent owns, including 529 savings / investment plans) in the determination of how much the family is expected to contribute to a student’s college education, each year.

Additionally, it is uncertain as to how much or what types of financial aid will be available to families in the future. But one thing is certain, a family that has made the sacrifice to save for their children’s college education typically has more options available when their children are ready to attend college.

Every effort is made to keep information accurate, however each qualified state tuition program operates under individual state laws, so programs may vary by state.

Source : collegesavings.org