529 Plan Basics – Part I of V

Most two year olds by now have added “yellow school bus” to their vocabulary, with the familiar vehicles on the roads, as schools have welcomed back their students.  In honor of those on the road to academic success, we are dedicating our next five podcasts to 529 plans – a popular way many families are saving for college.

Now, you’ve got to do a lot of homework before you start saving for college (and, let’s be clear from the start, saving for college with a 529 plan is just one option).

We think our podcasts will help you learn the basics of 529 plans – just like one of those little yellow books got you through War and Peace. 

But believe me - understanding 529 plans isn’t that hard.  Still, we know many investors have questions about fees, taxes, financial aid, and we are dedicating episodes focused on each of those topics. 

But that’s the future – today’s episode will answer only one question – what is a 529 plan? A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs.  Okay, we’re done.  Thanks for listening.  Your Money is brought to you by . . . .

Okay, there’s a little more than that to 529 plans.  If you’re a lawyer, you might refer to them by their legal name “qualified tuition plans,” and if you’re a tax guru, you might know that they’re authorized by and named after Section 529 of the Internal Revenue Code.  And if you’re anyone else – and this is just my view – you might be much more interesting to hang out with. 

When you contribute to a 529 plan, you save for a specific beneficiary.  Typically, the beneficiary can be anyone - a child, grandchild, niece, nephew, a third cousin twice removed, a friend, neighbor, even that good looking lifetime learner in the mirror. 

529 plans are sponsored by states, state agencies or educational institutions.  You’ll hear about two types:  pre-paid tuition plans and college savings plans.  All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a pre-paid tuition plan.

Let’s take a closer look at pre-paid tuition plans.  As the name suggests, pre-paid tuition plans generally allow college savers to purchase units or credits at participating colleges and universities for future tuition.  In some cases, you can also save for room and board through a pre-paid plan. 

Most plans set lump sum and installment payments based on age of beneficiary and number of years of college tuition purchased.   It’s like buying a gift certificate that reads “This gift certificate entitles beneficiary to go to State U and its affiliates for 4 years.”  When the beneficiary is ready to go to college, four years of tuition is paid, even though tuition prices likely have increased substantially since you started saving. 

College savings plan work differently. These plans generally permit you the college saver (also called the “account holder”) to establish an account for a beneficiary for the purpose of paying the beneficiary’s eligible college expenses.  Sorry - that language is for the lawyers and tax gurus, but the rest of you probably get the point.  Essentially, you save money in an account and use whatever is in the account to pay for your beneficiary’s college bills. 

If your account value is high when your beneficiary starts college, you might be able to cover all of your beneficiary’s college costs.  If you don’t save very much, however, your beneficiary will definitely need to find the school’s financial aid office. 

When you contribute to a college savings plan, you typically can choose among several investment options, which the college savings plan will invests on your behalf

Investment options often include stock mutual funds, bond mutual funds, and money market funds, as well as, age-based portfolios that automatically shift toward more conservative investments as the beneficiary gets closer to college age.   Some plans also have recently added certificates of deposit as a low-risk option. 

With this basic framework, let’s turn to a couple of common questions? 

Question 1:  Can a 529 plan beneficiary attend any school? 

For college savings plans, the answer is “yes.”  Withdrawals from college savings plans generally can be used at any college or university.  For pre-paid tuition plans, the answer also generally is “yes.” But keep in mind that pre-paid tuition plans are generally designed to be used at a select group of schools, typically in–state public universities.  So, in many cases, you likely will get more “bang for your savings buck” if the beneficiary attends one of the designated schools.  If you are considering a pre-paid tuition plan, be sure to read about how your account value can be applied to other schools.  

A second common question is:  Can I invest in a state’s 529 plan even if I don’t live there?  The answer depends on whether you invest in a college savings plan or a pre-paid tuition plan. 

For college savings plans, the answer typically is “yes.”  Most plans allow “out of state” residents to participate in their plan, although, in some cases, you might need to use a broker. 

You may not be able to invest in an out-of-state pre-paid tuition plan, however.  Some plans require that you or your beneficiary live in the state sponsoring the plan. 

That all said, it’s a good idea to check your own state’s plan first.  You may receive state tax or other benefits only if you invest in your home state’s plan.  More on taxes next time. 

Thanks for listening and be sure to subscribe if you want to hear the next four episodes on 529 plans.  Your Money is brought to you by the U.S. Securities and Exchange Commission.  You can reach us at podcast@sec.gov.