How Does a 529 College Savings Plan Work?
A 529 Plan, named after Section 529 of the Internal Revenue Code, is an educational savings plan operated by a state or educational facility, designed to help families set aside funds for future college costs.
A 529 Plan can be used to meet educational costs of any qualified colleges nationwide. In most plans, your choice of school is not affected by the state in which your 529 savings plan is located. You can be a TX resident, invest in a SC plan and send your student to college in NY.
Since the 529 Plan was created in 1996, every state now has approved at least one 529 plan. Each state gets to decide whether it will offer a 529 plan (or plans) and how it will be structured. This means that 529 plans can differ greatly from state to state. You should research the features and benefits of your plan before you invest. Your investment counselor or broker can assist you with this process.
As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant. For instance, although you cannot claim deductions for the annual contributions to the plan, the gains are tax-deferred, online and providing the fund is used for its intended purpose, tax exempt. Should the beneficiary decide not to attend college, the donor still has exclusive control of the funds, and can reclaim them, but will then have to pay federal income tax on the gains, as well as a 10% penalty.
Some states also offer substantial tax benefits on state income tax, so it becomes even more important to carefully research and compare all your options before deciding on a plan.
The allowable contributions, up to $300,000.00 in many states, are quite substantial, and management of the Plan is usually handled by either the State Treasurer or an appointed independent fund manager.
There are two specific types of 529 Plans: either prepaid plans or savings plans.
Savings Plans work much like a 401K or IRA by investing your contributions in mutual funds or similar investments. The plan will offer you several investment options from which to choose. Your account will go up or down in value based the performance of the particular option you select.
Prepaid Plans let you pre-pay all or part of the costs of an in-state public college education. They may also be converted for use at private and out-of-state colleges.