529 Plan

A 529 plan is a college savings account. It gives you tax benefits and the opportunity to invest in the stock market.

529 Plan explained

You can set up the plan yourself at the plan administrator. The beneficiary and heir should be named (in case the account holder dies). The beneficiary is usually a child, but can be other family members, including a spouse or even the account holder himself.

In order not to "get" 529 plans on the gift-tax, annual deposits per beneficiary must not exceed $15,000 per year. You are allowed to contribute for the next 5 years (i.e. $75,000). If taxes are filed as "married filing jointly," all limits are doubled.

The 529 plan contributions go net, but some states offer tax credits. Qualified withdrawals from the 529 plan can be used for college expenses (fees, study materials: books, computer). It is also possible to pay for school tuition, but in this case the use is limited to $10,000 per year. The plan can also be used to pay for college expenses abroad.

In the case of an unqualified withdrawal, pay income tax and a 10% penalty on the growth of the contribution. Additional state penalties are possible. Also, if a state tax credit was taken for the deposits, that amount will need to be paid back as well.

If the amount withdrawn from the 529 plan is given to the beneficiary, it should be on the beneficiary's tax return, not the account holder's. Sometimes this can lower the tax, for example: the child (beneficiary) may have a lower income than the parent (plan owner).

If a child receives a scholarship, then an amount equal to the financial aid received can be withdrawn from the 529 plan without penalty (tax is paid in proportion to the growth of the deposit).

Specifics of investing

Each state offers different 529 plans, sometimes even several! If you live in a state that gives tax deductions, there's little choice where to open a plan.

If your state doesn't give tax credits for contributions to a 529 plan, you can choose any state's plan.

Each plan comes from a specific state, and has a plan administrator (a management company), which usually co-operates with a broker or other fund provider. In fact we have a situation: "middleman on middleman" - a bit like a 401k plan. Also possible high administration fees, limited selection of (possibly expensive) funds, and lack of transparency. But unlike a 401k, we open a 529 plan on our own, not through an employer.