The Benefits of 529 Plans - Adviser Investments

The Benefits of 529 Plans

A Smarter Way to Save for College

Over the next several updates, we’ll be discussing 529 plans, which are fantastic, tax-advantaged vehicles for investors helping a child, relative, friend or even themselves save for tuition and expenses related to higher education. This week, we’ll start with the basics, and in future Adviser Fund Updates we’ll cover financial aid and tax ramifications, as well as review of some of the plans currently available.

What is a 529?

529 Plans, as mentioned above, are designed specifically to help folks save money for college. Plans are sponsored by states, generally in partnership with a mutual fund company or institute of learning, and usually offer either a number of investment options to choose among or a means of locking in a tuition rate. Anyone can set up a 529 plan for a designated beneficiary, and all withdrawals that go towards “qualified educational expenses” (which include tuition, room and board, books, a computer and peripherals, and even internet access) are exempt from federal and (usually) state taxes.

There are no income restrictions and no limit to the number of plans you can enter into, though withdrawals above and beyond the costs of those qualified education expenses (or non-qualified withdrawals in general) are subject to federal and state income tax, as well as a 10% penalty.

Even though 529 plans have been around since 1996 (the “529” comes from the relevant section of the Internal Revenue Service’s tax code), a May 2013 Edward Jones survey of over 1,000 people found that nearly 70% of participants did not know what they were, including 49% of households making $100,000 or more. Despite this relative lack of awareness, assets in 529 plans grew by 25% in 2012 to $166 billion, according to Morningstar.

With the average annual cost of tuition, room and board at a four-year private college continuing to soar (up 4.1% year-over-year to $39,518 in 2012–2013, and considerably more at the most exclusive schools), parents, grandparents and other interested benefactors cannot start saving soon enough.

Two Types of 529s, Equally Tax Exempt

529 plans come in two flavors: Savings plans and prepaid tuition plans—take a look at the table below to see a list of characteristics for each. States have their own unique plans, and are allowed to offer both savings plans and prepaid tuition plans. Many states do offer additional tax benefits for residents, but you are not restricted to the plan in your home state. For certain investors, it will be worthwhile to explore plans in other states to find the best fit.

Savings Plans

A good comparison for savings plans is a Roth IRA, to which you contribute after-tax income and then can make tax-free withdrawals from in retirement (for more on Roth IRAs, please click here). A 529 plan operates under the same basic principle (contributions cannot be deducted from your federal taxes), but is solely geared to the costs of college or university. Your 529 will be invested in mutual funds, so your return depends on the performance of the holdings in your portfolio. You’ll have the opportunity to invest in a selection of individual stock, bond and money market funds, and many plans feature pre-made portfolios, including age-based options that automatically reallocate funds from stock holdings to lower-risk bond and money market funds as the beneficiary gets closer to college age.


The Two Types of 529 Plans


College Savings Plan Prepaid Tuition Plan
No lock on secondary education costs. Locks in tuition prices at eligible public and private colleges and universities.
Covers all qualified higher education expenses: Tuition, room and board, fees, books, computers, internet access. Plans cover tuition and mandatory fees only.
Many plans have contribution limits in excess of $300,000 per beneficiary. Most plans set lump sum and installment payments prior to purchase based on age of beneficiary and number of years of tuition purchased.
Investment options are subject to market risk. Your investment could decline in value. Many state plans backed or guaranteed by the state.
No age limit. Open to adults and children. Most plans have age/grade limit for beneficiary.
No residency requirement. Nonresidents may only be able to purchase some plans through financial advisers or brokers. Most state plans require owner or beneficiary to be state resident.
Can change beneficiary to another family member if money is no longer needed. Refunds or transfer options vary state by state.
Enrollment open all year. Most plans have limited enrollment period.

Source: Smart Saving for College, NASD.

Investors have two types of savings plans to choose from. In direct-sold savings plans, investors buy 529s directly from a given state’s plan, are responsible for their own research and pay no sales charges. This type of plan is good for the cost-conscious, do-it-yourselfer who doesn’t mind taking the time to research which state’s plan is the best fit and is comfortable choosing among the available investment options.

If you do not wish to pick your own investments, you can go through a broker, who will invest your money for you, but at a price. Broker-sold programs can be subject to fees, sales charges and/or annual distribution fees, all of which can cut into your potential gains.

Prepaid Tuition Plans

Any college, university, vocational school or other postsecondary education institution is generally eligible to participate in prepaid tuition plans. This type of 529 plan enables college savers to buy credits at participating schools to lock in future tuition prices. Most prepaid tuition plans are sponsored by state governments for residents, and cover tuition and fees only (books and room and board are excluded). They are typically guaranteed by the state backing them.

With prepaid tuition plans, you are not investing in mutual funds—instead, you are making a bet against rising tuition prices. Depending on the state or plan there may some flexibility in where you can apply your credits, but these types of plans are often optimized for in-state school tuition—for out-of-state or private schools, you may find yourself having to make up the difference between the plan’s assigned value and tuition out of pocket (some private schools do participate in prepaid tuition plans, however). It should be noted that many of these plans require you to start investing years before your beneficiary is of college age, and they do not guarantee admission to participating schools. If your beneficiary chooses not to attend college or is not accepted, most states have refund options, or the plan can be transferred to another family member. Prepaid plans can be a good fit for some, but they have more strings attached than savings plans and offer less of an opportunity to grow your investment beyond the cost of in-state college tuition.

Further Reading

Smart Ways to Save (and Pay) for Education

States, Taxes and 529s

Review of Vanguard 529 Plans

About Adviser Investments
Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFs, fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the fifth consecutive year, Adviser Investments was named to Barron’s list of the top 100 independent financial advisers nationwide and its list of the top advisory firms in Massachusetts in 2017. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015 and 2016.

For more information, please visit or call 800-492-6868.

Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

The Barron’s rankings consider factors such as assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work. This award does not consider client experience and is not indicative of future performance.

Editors at the Financial Times bestowed “elite” status on 300 firms in the U.S., as determined by assets under management, asset growth, longevity, compliance record, industry certifications and online accessibility.

© 2018 Adviser Investments, LLC. All Rights Reserved.