Things to know before you open a 529 Plan

While there are now more 529 plans, also known as Qualified Tuition Programs (QTP), available than ever before and they seem to be experiencing a significant increase in popularity, the United States Congress created them back in 1996. These flexible plans have many tax advantages and can be a great way to save for college for you. Your children, or your grandchildren. With all the advantages, there are some drawbacks and other details that you should keep in mind when determining whether or not a 529 is the best option available to you for covering college costs.

Two types of plans:

Prepaid tuition plans seem like a sure thing on the surface, but many financial advisers are critical. These types of plans are most often sponsored by states. The plans are based on the assumption that when the cost of college tuition increases, the state that sponsored the plan will pay any differences. But many states have been unable to meet their financial obligations in recent years and programs like prepaid tuition are among the first to be cut.

There have been several states that stopped new enrollments into their program or have ended prepaid tuition plans altogether since 2008. Programs still in existence often limit college choices to public colleges within the sponsoring state. If the states fulfill their obligation, prepaid plans can save a significant amount of money. However, trusting that states will be financially able to do this year from now seems more like a gamble than an investment. Educational institutions can only offer prepaid plans and they are available at about 270 colleges.

Savings plans

The most popular type of 529 is a savings plan that is similar to many other tax-deferred savings plans. One key difference is that the IRS allows only one exchange or reallocation of funds each year for QTPs. Other key points to keep in mind are that any money withdrawn from this plan that is not used for qualified college expenses will be taxed as income and subject to an additional 10 percent federal tax penalty. Using a 529 for college tuition can also disallow a student’s ability to obtain need-based financial aid.

Contribution limits

You cannot contribute more than is needed to pay for the educational expenses of your beneficiary. If your contributions to the 529 plan, plus any other gift amounts, exceed $14,000 in a year. You may be subject to gift tax consequences. You are able to set up as many different plans as you choose for relatives and friends. And you can contribute to a plan for your own college education. The U.S. Securities and Exchange Commission list what qualifies as covered college expenses.

As prepaid plans seem to be declining in popularity, an increasing number of financial institutions are offering college savings plans. These plans work best when a parent begins saving for a child’s college education while the child is very young. Over time, they can gradually move the assets to a lower risk investment as the son or daughter nears college age.