A 529 college savings plan is a tax-advantaged investment designed to ease saving for higher-education expenses. Also known as a qualified tuition “savings” program, the plan is named after Section 529 of the Internal Revenue Code, which spells out the tax rules of the investment.
With a 529 college savings plan, you can name anyone — even yourself — as a beneficiary, and anyone can contribute to the fund. But, as with other types of investments, you risk losing money in addition to other drawbacks such as contribution limits and administration costs.
Don’t confuse a 529 college savings plan with the 529 prepaid tuition plan, which is a different type of investment also established by Section 259 of the IRS Code. The prepaid plan allows you to purchase tuition credits at their current rates for future use. To understand all your investment options, read our guide to 529 prepaid tuition plans and our overall guide to college savings options.
Below, we weigh the pros and cons of 529 college savings plans, describe how they work in greater detail and identify the costs to help you decide if they’re right for your financial situation. Keep reading to learn more.
Pros And Cons Of 529 College Savings Plans
Tax-deferred growth, the power of compound interest and tax-free withdrawals are the primary advantages of a 529 college savings plan. But to give you a more complete picture of what these special saving vehicles do and do not bring to the table, we evaluated their strengths and weaknesses relative to the other main type of account in which people typically stash cash earmarked for higher education — a standard brokerage account.
| Pros | Cons |
|---|---|
| Tax-free withdrawals on earnings if used for college | Funds can only be used for college expenses |
| Minimal financial aid impact | Unqualified withdrawals taxed as regular income and subject to 10% penalty |
| Does not affect eligibility for American Opportunity or Lifetime Learning tax credits | Tax-free portion of scholarships & grants counted against 529 contribution limit |
| — | You’ll lose extra perks offered by your home state if you choose a different state’s 529 plan |
| — | Investment options can only be changed once a year or when you change your beneficiary |
| — | Charges plan-management fees |
How A 529 College Savings Plan Works
Nearly every state, plus the District of Columbia, offers and operates its own 529 college savings plan. You may choose among other states’ plans besides the one from your home state. Some states offer additional perks — such as state tax deductions and matching grants or scholarships — that are available exclusively to residents, especially low- and middle-income families. Others will also shield the investment’s assets from creditors or exempt them from state financial aid calculations, boosting a student’s need-based aid, if necessary.
Under a 529 college savings plan, your contributions are invested in a state-approved and monitored investment portfolio. The value of your investment can go either up or down based on market performance. In other words, you bear the risk of losing money on the investment, and state sponsors offer no guarantees. You can change your investments once every calendar year or whenever you change your beneficiary.
| 529 College Savings Plan Features | |
|---|---|
| Investment Options | Various Mutual & Exchange-Traded Funds |
| Age-Based: State plans that become increasingly conservative as college approaches | |
| Non-Age-Based: Certificates of Deposit or portfolios with conservative, moderate or aggressive asset allocations | |
| Qualified Expenses | Tuition & Fees |
| Books & Supplies | |
| Room & Board | |
| Computers & Other Equipment (must be required by school) | |
| Special-Needs Educational Services | |
| Eligible Institutions | Most Public Colleges/Universities |
| Most Private Colleges | |
| Graduate Schools | |
| Certain Post-Secondary Education Institutions Abroad | |
529 College Savings Plan Fees
The cost of a 529 college savings plan depends on how it is sold:
- Direct-Sold (generally cheaper): You purchase directly from the state sponsor/plan manager. You can either select investments yourself or pay a financial adviser to help you. Professional investment firms manage these plans, but the plans do not incur sales charges.
- Broker-Sold: You purchase from a broker or financial adviser. The advantage to this option is having the expertise of an investment professional. The downside is that you’ll most likely pay sales charges — and possibly other fees.
Caution: If you’re not a resident of the state operating your plan of choice, you may be required to purchase the plan through a broker, depending on the sponsor state.
The following table summarizes the possible charges you may incur on a 529 college savings plan.
| Charge | Estimated Cost | Additional Info |
|---|---|---|
| Enrollment Fee | Typically $50 or less | Many state plans do not charge this fee |
| Annual Maintenance Fee | $10–$25 | May be reduced or waived for participating residents who make automatic contributions or maintain a minimum balance (typically $25K) |
| Sales Charge (Front-End Sales Load) | Typically 3%–5% | Charged by some state plans when you buy certain investment options within a plan or purchase a plan through a broker |
| Deferred Sales Charge (Back-End Sales Load) | Varies but typically starts at 2.5% for 1st year and decreases every year until zero | Charged by some state plans when you withdraw money from the plan |
| Annual Distribution Fee | 0.25%–1.00% of the investment | This is a commission for the broker |
| Administration/Asset Management Fee | 0.00%–1.00% of the plan's assets | The “plan’s assets” include both the principal and interest earned |
| Underlying Fund Expenses | 0.00%–0.25% of a mutual fund's assets | When an investment offered is a bundle of mutual funds, there are fees associated with each of the included mutual funds |
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