Section 529 Plans: A Tax-advantage Investment Vehicle For Your Child's FutureParents in the United States are encouraged to save for their child's future higher education expenses through section 529 plans, a tax-advantage investment vehicle. State legislation regulates the details of the section 529 plans. Most plans allow out-of-state investors to contribute. However, for investors who are state residents, there are significant state tax advantages and other benefits. These include matching grant and scholarship opportunities, protection from creditors and exemption from state financial aid calculations. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which brought important changes to retirement plans and increased estate-tax exclusions, also made section 529 plans more prominent with its tax advantages. Prior to EGTRRA, distributions were taxed based on the beneficiary's federal income rate. Now, distributions from section 529 plans for qualified higher education expenses are exempt from federal income taxes. Further, the provisions in EGTRRA would have expired in 2010, but the Pension Protection Act of 2006 made them permanent. There are two types of section 529 plans available: prepaid and savings. Tuition credits can be purchased at today's rates for future use with the prepaid section 529 plans. The amount increases as tuition costs rise each year prior to the beneficiary's college or university enrollment. Funds available in the savings plans are dependent on the market performance of the mutual funds typically used to invest the contributions. Most section 529 plans have a variety of asset allocation options for account owners to choose from. Generally, as the beneficiary gets closer to college age, the underlying investments are more conservatively tailored. This is similar to retirement accounts. Also, risk-based asset allocation options are available and maintain the same equity-to-fixed income ratio. The beneficiary's age is not a determining factor. The investor's principle payment is protected by many of the section 529 plans. While only states are allowed to administer savings plans, prepaid plans can be administered by either the state of educational institutions. Record keeping and other administrative services are outsourced to a mutual fund or financial services company. Some of the advantages to section 529 plans include: all contributions are federal and state income tax free; the account holder controls the assets of the plan; the beneficiary can change at anytime to another family member; some states exempt income tax for withdrawals related to qualified higher education expenses; and, there are high maximum contribution limits. There are also some of the disadvantages. The high fees associated with section 529 plans make them less effective than traditional savings tools. |