If you’re interested in saving money for a child’s college education, you’ve most likely heard of a 529 plan. But understanding these plans enough to take advantage of their benefits takes a bit of (worthwhile) research. Get started with this quick breakdown.

What is a 529 plan?

A 529 plan is a way to save money for the cost of education without that money being taxed while you save. And, as long as the money saved is used for qualified education expenses, it won’t be taxed when it’s withdrawn for use.

Legally, these plans are called qualified tuition plans. “529” means they’re authorized by section 529 of the federal tax code, even though they are sponsored and run by the states. Each state, as well as the District of Columbia, has some form of a 529 plan.

How do you open a plan?

You can enroll in a 529 plan directly by going to the website for one of the plans offered by any of the states. You can also enroll through a financial advisor. You aren’t required to open a plan in the state you legally reside in, but doing so may make you eligible for the tax benefits we will break down a bit later.

How 529s work

Whether you open a plan yourself or through a financial advisor, you’ll get to choose where your funds are invested. Typically there are several options, including various mutual funds and exchange-traded funds (ETFs). Saving strategies differ from person to person, so select the one that best matches your goals and comfort level.

Most plans offer both a static investing approach and an age-based or target-based portfolio (one that changes as the beneficiary gets older). To save as much money as possible, target-based portfolios will usually shift to more conservative assets as the beneficiary gets closer to college age.

529 plan comparison guide

The two primary forms of 529 plans are prepaid tuition plans and the more common education savings plan.

• Prepaid tuition plans are used when you want to save money for tuition and mandatory fees at a particular college or university. They cannot be used for elementary or high school costs, and they do not cover room and board. Typically you can lock in lower tuition costs with this option than if you wait until your child or beneficiary is ready to attend the school.

• Education savings plans can be used to pay for tuition and mandatory fees at all participating United States colleges, universities (even some outside the U.S.), and trade schools, including the cost of room and board. They can also be applied in limited amounts to K-12 tuition, registered apprenticeship programs, and up to $10,000 to repay student loans. 

Illinois and Wisconsin each offer two 529 plans, Indiana has three: Bright Start and Bright Direction in Illinois, EdVest and Tomorrow’s Scholar in Wisconsin, CollegeChoice 529 Direct, CollegeChoice CD, and CollegeChoice Advisor in Indiana. Bright Start, EdVest, and both CollegeChoice Direct and CD are direct-open plans, the other options are advisor-guided.

What are the tax benefits?

In addition to tax-free savings and withdrawals for qualified expenses, many states allow you to deduct contributions to a 529 plan from your state income taxes or will match these contributions with grants. Anyone can contribute to a 529 plan, not just parents, and all contributors may be eligible for income tax deductions.

You can contribute to a plan in a different state than you reside in, but remember that the tax benefits generally apply only if you contribute to a plan in your home state. Even then, state tax regulations differ, so it’s best to look up what your state’s regulations are, and check with a tax professional if you are planning a contribution.

What do they cost?

Some 529 plans have one-time enrollment fees while others do not, and there will likely be a service fee if you open through a broker. Some individual plans include ongoing maintenance fees, but there are usually low-fee options.

What happens to the funds if my child does not go to college?  

If the beneficiary does not attend college or receives substantial scholarships or benefits, there are multiple ways to make use of the remaining 529 savings.

The plan can be transferred to a qualifying relative, like a sibling, or it can remain in the name of the beneficiary in case they decide to attend college or incur other education expenses in the future. 529 savings can also be applied to the cost of trade schools, registered apprenticeship programs, and a few other education options. You can withdraw the funds for general use as well — just be prepared to pay state and federal taxes plus a 10% tax penalty since the funds aren’t being used for education.

Are you ready to start saving? Contact our financial advisors for additional information and start planning for college today.