529 Plans: How Saving for College Can Help You Save on Taxes

The Pros and Cons of a Qualified Tuition Plan

by Derek Campbell

Saving for college is no small task. Given how expensive higher education can be, every chance to save money along the way is important. One possible way to save money while saving for college is by taking advantage of Qualified Tuition Plans, also known as 529 Plans.

What is a Qualified Tuition Plan?

In sum, a 529 Plan is “a tax-advantaged savings plan designed to encourage saving for future college costs.” Furthermore, 529 Plans are sponsored either by state governments or educational institutions themselves.

Additionally, there are two kinds of 529 Plans: Pre-Paid Tuition Plans and College Savings Plans. Pre-Paid Tuition Plans allow college savers to purchase blocks of units or credits at a particular educational institution, and occasionally room and board. College Savings Plans involve an account holder who makes contributions for the future student, or “beneficiary.” The account holder chooses from among a number of investment options offered by the plan.

It’s worth noting the structure of these plans: state governments or educational institutions hire financial firms to manage these investments.

The Securities and Exchange Commission (SEC) has particularly comprehensive information about these plans.

The Pros

Unlike a traditional savings account, income that is put into a Qualified Tuition Plan is not taxed. Additionally, the growth of the account is not taxed either. This is the primary advantage of 529 Plans: they allow money specifically earmarked for college expenses to avoid taxation.

Every state and the District of Columbia offer 529 Plans, and this can be to the customer’s benefit. Certain state plans reward in-state residents–many Pre-Paid Tuition Plans require either the account holder or the beneficiary to be state residents. Some College Savings Plans with more advantageous terms can be accessed by out-of-state residents, but many of these plans must be purchased through brokers, who charge their own fees for the service.

Lastly, it’s worth noting that many Pre-Paid Tuition Plans are guaranteed against loss by the state governments that sponsor them.

The Cons

Funds put into 529 Plans are specifically meant for tuition and other educational-related expenses. If funds are removed from a Qualified Tuition Plan for purposes other than paying for school, income taxes are applicable to these funds, as well as penalties for removing the money from the plan.

Some Pre-Paid Tuition Plans have restrictions on the age or grade-level of the beneficiary. College Savings plans are more flexible in terms of what the funds can be used for (incidental expenses as well as official school tuition and fees), but their funds are not guaranteed by the state. Since these Savings Plans are often invested in stocks or mutual funds, they are exposed to market risk.

Are There Other Options?

Yes. In addition to Qualified Tuition Plans, there are numerous other programs that encourage savings for college. The College Savings Plans Network, offers more detailed information on these savings plans.