A 529 plan is a tax-advantaged savings plan designed to
encourage saving for future college costs. 529 plans, legally known as qualified
tuition plans, are sponsored by states, state agencies, or educational
institutions and are authorized by Section 529 of the Internal Revenue Code.
There are two types of 529 plans: 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.
Pre-paid tuition plans generally allow
college savers to purchase units or credits at participating colleges and
universities for future tuition and, in some cases, room and board. Most prepaid
tuition plans are sponsored by state governments and have residency
requirements. Many state governments guarantee investments in pre-paid tuition
plans that they sponsor.
College savings plans generally permit a
college saver (also called the account holder) to establish an account for a
student (the beneficiary) for the purpose of paying the beneficiary's eligible
college expenses. An account holder may typically choose among several
investment options for his or her contributions, which the college savings plan
invests on behalf of the account holder. 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. Withdrawals from college savings plans
can generally be used at any college or university. Investments in college
savings plans that invest in mutual funds are not guaranteed by state
governments and are not federally insured.
Investing in a 529 plan may
offer college savers special tax benefits. Earnings in 529 plans are not subject
to federal tax, and in most cases, state tax, so long as you use withdrawals for
eligible college expenses, such as tuition and room and board.
However,
if you withdraw money from a 529 plan and do not use it on an eligible college
expense, you generally will be subject to income tax and an additional 10%
federal tax penalty on earnings. Many states offer state income tax or other
benefits, such as matching grants, for investing in a 529 plan. But you may only
be eligible for these benefits if you participate in a 529 plan sponsored by
your state of residence. Just a few states allow residents to deduct
contributions to any 529 plan from state income tax returns.
If you
receive state tax benefits for investing in a 529 plan, make sure you review
your plan's offering circular before you complete a transaction, such as rolling
money out of your home state's plan into another state's plan. Some transactions
may have state tax consequences for residents of certain states.
It is
important to understand the fees and expenses associated with 529 plans because
they lower your returns. Fees and expenses will vary based on the type of plan.
Prepaid tuition plans typically charge enrollment and administrative fees. In
addition to loads. for broker-sold plans, college savings plans may charge
enrollment fees, annual maintenance fees, and asset management fees. Some of
these fees are collected by the state sponsor of the plan, and some are
collected by the financial services firms that the state sponsor typically hires
to manage its 529 program. Some college savings plans will waive or reduce some
of these fees if you maintain a large account balance or participate in an
automatic contribution plan, or if you are a resident of the state sponsoring
the 529 plan. Your asset management fees will depend on the investment option
you select. Each investment option will typically bear a portfolio-weighted
average of the fees and expenses of the mutual funds and other investments in
which it invests. You should carefully review the fees of the underlying
investments because they are likely to be different for each investment option.
Investors that purchase a college savings plan from a broker are
typically subject to additional fees. If you invest in a broker-sold plan, you
may pay a load. Broadly speaking, the load is paid to your broker as a
commission for selling the college savings plan to you. Broker-sold plans also
charge an annual distribution fee (similar to the "12b 1 fee" charged by some
mutual funds) of between 0.25% and 1.00% of your investment. Your broker
typically receives all or most of these annual distribution fees for selling
your 529 plan to you.
Many broker-sold 529 plans offer more than one
class of shares, which impose different fees and expenses. Here are some key
characteristics of the most common 529 plan share classes sold by brokers to
their customers:
1) Class A shares typically impose a
front-end sales load. Front-end sales loads reduce the amount of your
investment. For example, let.s say you have $1,000 and want to invest in a
college savings plan with a 5% front-end load. The $50 sales load you must pay
is deducted from your $1,000, and the remaining $950 is invested in the college
savings plan. Class A shares usually have a lower annual distribution fee and
lower overall annual expenses than other 529 share classes. In addition, your
front-end load may be reduced if you invest above certain threshold amounts .
this is known as a breakpoint discount. These discounts do not apply to
investments in Class B or Class C shares.
2) Class B
shares typically do not have a front-end sales load. Instead, they may charge a
fee when you withdraw money from an investment option, known as a deferred sales
charge or back-end load. A common back-end load is the contingent deferred
sales charge or contingent deferred sales load. (also known as a CDSC or
CDSL). The amount of this load will depend on how long you hold your investment
and typically decreases to zero if you hold your investment long enough. Class B
shares typically impose a higher annual distribution fee and higher overall
annual expenses than Class A shares. Class B shares usually convert
automatically to Class A shares if you hold your shares long enough.
3) Class C shares might have an annual distribution
fee, other annual expenses, and either a front or back-end sales load. But the
front or back-end load for Class C shares tends to be lower than for Class A or
Class B shares, respectively. Class C shares typically impose a higher annual
distribution fee and higher overall annual expenses than Class A shares, but,
unlike Class B shares, generally do not convert to another class over time. If
you are a long-term investor, Class C shares may be more expensive than
investing in Class A or Class B shares.
Note: Be
careful when investing in Class B shares. If the beneficiary uses the money
within a few years after purchasing Class B shares, you will almost always pay a
contingent deferred sales charge or load in addition to higher annual fees and
expenses.
Common Questions And
Answers
Is there any way to purchase a 529 plan but avoid some of the
extra fees?
Direct-Sold College Savings Plans:
States offer college savings plans through which residents and, in many cases,
non-residents can invest without paying a "load," or sales fee. This type of
plan, which you can buy directly from the plan's sponsor or program manager
without the assistance of a broker, is generally less expensive because it
waives or does not charge sales fees that may apply to broker-sold plans. You
can generally find information on a direct-sold plan by contacting the plan's
sponsor or program manager or visiting the plan.s website. Websites such as the
one maintained by the College Savings Plan Network, as well as a number of
commercial websites, provide links to most 529 plan websites.
Broker-Sold College Savings Plans: If you prefer to
purchase a broker-sold plan, you may be able to reduce the front-end load for
purchasing Class A shares if you invest or plan to invest above certain
threshold amounts. Ask your broker how to qualify for these breakpoint
discounts.
What restrictions apply to an investment in a 529
plan?
Withdrawal restrictions apply to both college savings
plans and pre-paid tuition plans. With limited exceptions, you can only withdraw
money that you invest in a 529 plan for eligible college expenses without
incurring taxes and penalties. In addition, participants in college savings
plans have limited investment options and are not permitted to switch freely
among available investment options. Under current tax law, an account holder is
only permitted to change his or her investment option one time per year.
Additional limitations will likely apply to any 529 plan you may be considering.
Before you invest in a 529 plan, you should read the plan's offering circular to
make sure that you understand and are comfortable with any plan limitations.
Does investing in a 529 plan impact financial aid
eligibility?
While each educational institution may treat assets
held in a 529 plan differently, investing in a 529 plan will generally reduce a
student's eligibility to participate in need-based financial aid. Beginning July
1, 2006, assets held in pre-paid tuition plans and college savings plans will be
treated similarly for federal financial aid purposes. Both will be treated as
parental assets in the calculation of the expected family contribution toward
college costs. Previously, benefits from pre-paid tuition plans were not treated
as parental assets and typically reduced need-based financial aid on a dollar
for dollar basis, while assets held in college savings plans received more
favorable financial aid treatment.
Is investing in a 529 plan
right for me?
Before you start saving specifically for college, you should consider your
overall financial situation. Instead of saving for college, you may want to
focus on other financial goals like buying a home, saving for retirement, or
paying off high interest credit card bills. Remember that you may face penalties
or lose benefits if you do not use the money in a 529 account for higher
education expenses. If you decide that saving specifically for college is right
for you, then the next step is to determine whether investing in a 529 plan is
your best college saving option. Investing in a 529 plan is only one of several
ways to save for college. Other tax-advantaged ways to save for college include
Coverdell education savings accounts, Uniform Gifts to Minors Act (UGMA)
accounts, Uniform Transfers to Minors Act (UTMA) accounts, tax-exempt municipal
securities, and savings bonds. Saving for college in a taxable account is
another option.
Each college saving option has advantages and
disadvantages, and may have a different impact on your eligibility for financial
aid, so you should evaluate each option carefully. If you need help determining
which options work best for your circumstances, you should consult with your
financial professional or tax advisor before you start saving.
Where can I find more
information?
Offering Circulars for 529 Plans:
You can find out more about a particular 529 plan by reading its offering
circular. Often called a disclosure statement, disclosure document, or program description,. the offering circular will have detailed information
about investment options, tax benefits and consequences, fees and expenses,
financial aid, limitations, risks, and other specific information relating to
the 529 plan. Most 529 plans post their offering circulars on publicly available
websites. The National Association of State Treasurers created the College
Savings Plan Network which provides links to most 529 plan websites.
Additional Information About Underlying Mutual Funds:
You may want to find more about a mutual fund included in a college savings plan
investment option. Additional information about a mutual fund is available in
its prospectus, statement of additional information, and semiannual and annual
report. Offering circulars for college savings plans often indicate how you can
obtain these documents from the plan manager for no charge. You can also review
these documents on the SEC's EDGAR database.
Investment Adviser
Public Disclosure Website: Many college savings plans program managers
are registered investment advisers. You can find more about investment advisers
through the Investment Adviser Public Disclosure website. On the website, you
can search for an investment adviser and view the Form ADV of the adviser. Form
ADV contains information about an investment adviser and its business operations
as well as disclosure about certain disciplinary events involving the adviser
and its key personnel.
Broker-Dealer Public Disclosure
Website: You can find more about a broker through FINRA's BrokerCheck
website. On the website, you can search for any disciplinary sanctions against
your broker, as well as information about his or her professional background and
registration and licensing status.
Other Online
Resources: You can learn more about 529 plans and other college saving
options on FINRA's Smart Saving for College website. The website contains links
to other helpful sites, including the College Savings Plan Network and the
Internal Revenue Service's Publication 970 (Tax Benefits for Higher Education)
FINRA's investor alert on 529 plans also provides valuable information for
investors.