529 College Savings Plan Overview

Much like a 401(k) is a savings plan for retirement, a 529 plan is a savings plan for college. You can set up a 529 plan on your own, and don't need to go through your employer. These state-sponsored savings plans let you build up savings, tax-free, for tuition in any college or university

The tax advantage of a 529 plan, which includes tax-free withdrawals for college tuition (and in some cases other college expenses), makes this savings plan more inviting than a regular savings account. Of course, like any savings account with a future goal in mind, the longer your time frame, the more you can save. Therefore, you may start considering such a college savings plan when your kids are still in elementary school.

In addition, any individual can contribute to the plan. Relatives, friends, colleagues, acquaintances, and even complete strangers can contribute to a child's section 529 plan. 529 College Savings Plans have contribution limits. Contributions are treated as completed gifts for federal tax purposes. Persons may contribute up to $11,000 annually per beneficiary, or $22,000 for married couples who file joint tax returns, without exceeding the federal gift tax exclusion. Additionally, clients can contribute up to $55,000 per beneficiary, or $110,000 for a married couple filing jointly, in the first year of a five-year period, provided no additional gifts are made during that same five-year period. Anyone may contribute, regardless of income or state residency. Finally, a person making a contribution to a 529 College Savings Plan can also make a contribution to a Coverdell Education Savings Account in the same year.

Federal law requires that a 529 College Savings Plan have safeguards to prevent contributions in excess of those necessary to provide for the qualified higher education expenses of the beneficiary, but does not otherwise specify a limit on contributions. Each state, therefore, sets its own limits. Most states use a limit based on an estimate of the amount of money that will be required to provide seven years of post-secondary education (including both undergraduate and graduate school). Even so, there is considerable variation in state cumulative contribution limits, which range from $146,000 to $305,000. The median limit is $235,000. This is a means of growing a plan in a hurry, making it intriguing for grandparents looking to help fund the education of their grandchildren, while also lowering their taxable estate.

Before seeking out a 529 plan, keep in mind that they vary from state to state, and they invest primarily in mutual funds, which indicates a degree of risk and fees to pay. Review various plans, and look for those that are no-loads or low-loads. If you live in a state such as New York, with its high state taxes, you can benefit from the tax advantage, and your child does not have to attend a college or university in New York as a result.

Earnings grow federally tax-deferred until withdrawn. Proceeds may be used at any accredited post-secondary school in the U.S. for part- and full-time education. Beneficiaries receiving 529 income remain eligible for the HOPE scholarship and Lifetime Learning Credit in the same year.

Some 529 College Savings Plans move your investment dollars from more aggressive assets, such as stocks, to more conservative investments, including bonds and money market funds, as college approaches. See if you can find one with this type of asset allocation. Even if you can't, you may want to take this approach when managing your child's 529 plan.

Another advantage of a 529 College Savings Plan is that the money in the account is controlled by the parent and considered a parental asset. This means it won't significantly affect financial aid.

Keep in mind that at present, Congress has approved federal tax exemptions on withdrawals from 529 plans only through 2010. It will need to extend the tax-free status to ensure that children headed to college after 2010 will also benefit from tax-free withdrawals.

At the moment, 529 College Savings Plans are relatively new, so the investment options are somewhat limited. Such plans (which have a high investment ceiling of more than $200,000) will very likely become more popular, because of the significant costs of college tuition. If you have a college-bound student, 529 College Savings Plans are worth exploring.