Qualified Tuition Plans
A qualified tuition plan, known more commonly as a 529 plan, is a college savings plan that gives tax benefits to both the contributor and the recipient. The big advantage of a 529 plan is that it allows earnings in the account to grow tax-free and to be withdrawn tax-free at the federal level.
A 529 plan is typically organized through a specific state, and contributors who use their own state plan may receive certain state tax benefits as well. For example, contributors to 529 plans in some states may be able to deduct their donations from their own state income tax and withdraw earnings at the state level tax-free. Contributors who use other state plans typically do not receive tax benefits at the state level.
The 529 plan comes in two types.
- 1. Prepaid tuition plans allow investors to purchase units or credits at participating colleges for future tuition. A semester’s worth of prepaid tuition at today’s prices would pay for a semester’s worth of tuition at any future date. Most prepaid tuition plans are sponsored by state governments and have residency requirements. Investments into the plan are generally guaranteed.
- 2. College savings plans permit the investor to establish a savings account to pay for a student’s eligible college expenses. The contributor typically chooses from several investment options. Options that invest in mutual funds are not guaranteed or insured by the federal government. Withdrawals can generally be used at any college or university.
All 529 accounts are funded with after-tax dollars. Withdrawals come out tax-free if used for qualified educational expenses (tuition, books, room and board, computers, and mandatory fees). Withdrawals are subject to a 10% penalty, and earnings will be taxed if the money is used for other purposes. At the beginning of 2018, the definition of qualified expenses was expanded to include up to $10,000 per beneficiary per year for elementary or sec