From the May 2010 newsletter:
529 plans are one of the easiest ways to save for your child’s college education. Investment earnings are tax-free as long as withdrawals are used for qualified college expenses. And unlike other options, there are no income or age restrictions. There are two main decisions when opening a 529 account: which 529 plan to use and which investments to buy.
Although there are 529 plans sponsored by each state, you can open an account with a plan in any state. The main factors in selecting a 529 plan are: state tax benefits, expenses, and investment options. To keep your expenses low, the direct-sold plans (CA, NY, NV, etc) are your best bets.
The second decision is your investment strategy. Like most 401k plans, 529 plans have a limited selection of investments. The easiest investment to use is the age-based option, which is similar to the target-date fund in your 401k. Or, you can build your own portfolio using the available investments. However, your ability to trade is limited (generally once or twice a year).
Check out the summary of features and restrictions below. If you’re deciding between the age-based option and building your own portfolio, take a look at this blog post that evaluates age-based options using NY’s as an example.
529 Plan Features and Restrictions
This general information is from the SEC website, but before investing you should verify the features of your specific 529 plan. Trust, but verify.
- Contributions may reduce state income tax (differs by state), but not federal tax
- Contributions may be subject to gift tax
- Withdrawals are exempt from state and federal income tax as long as they are used for qualified higher education expenses
- Withdrawn earnings not used for qualified expenses are subject to state and federal income tax plus a 10% penalty
Qualified Higher Education Expenses
- Room & board
- Mandatory fees
- Books, computers (if required)
- Withdrawals can generally be used at any college
- Remaining balance can be transferred to a family member
- No income or age limit
- Very high contribution limit (generally $200,000 to $300,000, or more)
- Investment options are limited by the plan, similar to a 401k
- Trading is restricted, usually limited to one trade per calendar year
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