So here's the deal:
In 1998, Section 529 of the Internal Revenue Service Code created certain types of educational savings plans. These plans are operated by the state or educational institutions to help families set aside money for future educational expenses. Every state in the union currently has at least one type of 529 plan available. The two main types of 529 plan are the Savings Plan and the Prepaid Plan.
I will attempt to explain the 529 Prepaid Plan today.
Prepaid plans allow you to pay all or part of college costs in advance. State sold prepaid plans cover costs for in-state public colleges but can usually be converted if the student wants to attend an out of state or private school. The Independent 529 plan is a separate prepaid plan that can be bought through the Tuition Plan Consortium for participating private schools.
There are several options, depending on the state, for these plans. You can cover tuition, fees, dormitory costs and combinations of the above. You can plan for 1 year or a 2 year college or 4 year college. Generally you enroll directly into the program through the appropriate state agency. Enrollment periods vary. Some, but not all, states have residency requirements for either the purchaser or the beneficiary. Payment plans can include lump sum, 5 year plan, or fixed monthly payments. Costs vary widely depending on the length of the plan, which fees are included and the age of the beneficiary at the time of enrollment.
One of the most important benefits of the prepaid plan is the ability to "lock in" the tuition rate at the time you purchase the plan. Plans have a built in interest rate that is applied to cover the projected cost of college when the beneficiary is of age. If the inflation rate of these costs exceeds the projected cost, your payments stay the same and the actual costs are still covered in full. In my opinion, the peace of mind that comes from knowing you won't have to pony up more than you have budgeted for is priceless.
Other benefits are:
1. Investment growth is tax-deferred. Payments made for the beneficiary's college costs are federally tax-free.
2. Some states have tax benefits as well.
3. Once you enroll, the plan takes care of itself. The plan's assets are controlled by the plan's program manager.
4. The plan is flexible and can usually be transferred to another beneficiary.
Some drawbacks do exist:
1. Some plans can be counted against financial aid.
2. There can be penalties for withdrawing funds from an unused plan.
3. The plan constitutes a gift to the beneficiary as far as gift tax is concerned. However, it qualifies for the $12,000/year exclusion. You can spread this out over 5 years, effectively sheltering up to $60,000 per beneficiary.
As you can see, there are literally hundreds of combinations of variables that can affect the cost and usefulness of these plans. If you have teens and have not started saving for their educations, time is of the essence. When comparing these plans, that needs to be taken into consideration.
There are several websites available that show plan comparisons by state.
Savingforcollege.com is one that can help you with many of the details.
Up next: The 529 Savings Plan