529 plan / qualified tuition program
Qualified tuition plans
529 plans, known as ‘qualified tuition plans’, are tax-advantaged savings plans for future education costs. These plans are authorized by Section 529 of the Internal Revenue Code, and are sponsored by states, state agencies, or educational institutions. There are two types of 529 plans: prepaid tuition plans and education savings plans.
Qualified tuition plans are sponsored by states, state agencies, or educational institutions. All fifty states sponsor at least one type of plan. Additionally, a handful of private colleges and universities sponsor a prepaid tuition plan.
What is the difference between the prepaid tuition plans and education savings plans?
Prepaid Tuition Plans: this type of plan allows the account holder to purchase credits or units at participating colleges and universities, to use for future tuition and other mandatory fees. These plans cannot be used to pay for your room at colleges and universities.
Typically, prepaid tuition plans are sponsored by state governments and not guaranteed by the federal government. While some state governments guarantee the money paid into the prepaid tuition plans they are sponsoring, others do not. If the prepaid payments aren’t guaranteed and the sponsor experiences financial shortfall, you are at risk of losing some or all of your money in the plan.
Education Savings Plans: this type of plan allows an individual to open an investment account to save for future qualified higher education expenses (tuition, other mandatory fees, and room and board). Withdrawals from these plans can be typically used at any college or university, sometimes including non-US colleges and universities.
While the prepaid tuition plan does not allow you to prepay for tuition for elementary and secondary schools, the education savings plan can also be used to pay for tuition at any public, private or religious elementary or secondary school (up to $10,000 per year per beneficiary).
Only a few education savings plans have residency requirements for the saver and/or beneficiary, despite all being sponsored by state governments.
Are 529 plans qualified or nonqualified?
This is dependent on the distributions or withdrawals that you make with the plan’s savings.
What are qualified expenses for 529 plans IRS?
So, for the prepaid tuition plans, qualifying expenses include tuition and other mandatory fees, but not room and board, at participating colleges and universities.
Fort the education savings plans, qualifying expenses include tuition, mandatory fees, room and board at college and university. Additionally, this plan can be used to pay for tuition at public, private, or religious elementary or secondary schools, with up to $10,000 available per year per beneficiary.
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Can you lose money in a 529?
A saver under an educations savings plan can choose among a range of investment portfolio options, including various mutual funds and exchange-trade fund (ETF) portfolios and a principal-protected bank product. If you are using your 529 plan to pay for elementary or secondary school tuition, you will face a shorter time horizon for your money to grow. Investment into education savings plans may not make any money and you could face losses.
Will I face fees and expenses for investing in a 529 plan?
Fees and expenses vary depending on the type of 529 plan, whether it is a broker or direct sold plan, and any underlying investments. By carefully reviewing the plan’s offering circular, you can find out what fees you will be charged for the plan and investment options.
Prepaid tuition plans may charge:
- Enrolment/application fee
- Any ongoing administrative fees
Education savings plans may charge:
- Enrolment/application fee
- Annual account maintenance fees
- Any ongoing program management fees
- Any ongoing asset management fees – dependent on the investment option you choose.
- Sales loads or charged at the time of investment, or redemption and ongoing distribution fees – If purchasing an education savings plan from a broker, you are typically subjected to these additional fees.
What restrictions apply to 529 investments?
Investments: under tax law, an account holder can only change their investment option twice a year when there is a change in beneficiary.
Withdrawals: generally, you can only withdraw money that you invest in an education savings plan for qualified higher education expenses or elementary or secondary school tuition fees, without incurring taxes or penalties. For prepaid tuition plans, beneficiaries of the plan can only use their purchased credits or units at participating colleges and universities.
Does investing in a 529 plan affect federal and state taxes?
Depending on the state and type of 529 plan, investing in a 529 plan can offer special tax benefits.
- Many states offer tax benefits for contributions to a 529 plan, including the deduction of these contributions from state income tax. You are only eligible for these benefits if you have invested into a 529 plan that is sponsored by your state of residence.
- If you use your 529 account to make withdrawals for qualified higher education expenses or tuition for elementary or secondary schools, earnings made in your 529 account will not be subject to federal income tax, and in most cases, state income tax. If withdrawals are not used for these reasons, they will be subject to taxes and an additional 10% federal tax penalty on earnings.
The longer your investment, the more money you will grow, and therefore the greater your tax benefits.
Does investing in a 529 plan affect financial aid?
Investing into a 529 plan will impact a student’s eligibility for needs-based financial college aid. However, the more you save, the less debt the student will have to incur through loans.