So what exactly is Plan 529?
A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996. Today, it is an increasingly popular way to save for higher education expenses.
History behind Plan 529
Plan 529 was originated from states rather than the federal government. With the increase in the tuition cost every year, the state-run prepaid tuition program of Michigan proposed thousands of Michigan households with the working of Plan 529 which was to be managed by Michigan Education Trust (MET).
This provided an opportunity to prepay future tuition, which would not to be affected by future tuition increases. The initiative sparked interest in other states, which launched their first prepaid tuition program. Later on with the increasing popularity, the government of States made it legal under section 529 of the Internal Revenue Code 26 USC. Till today the prepaid program of MET remains as one of the largest and most successful pre-paid programs.
There are two types of 529 plans - prepaid plans and savings plans.
Prepaid Plans - Prepaid plans allow one to purchase tuition credits at today's rates to be used in the future. Therefore, performance is based upon tuition inflation. Prepaid plans may be administered by states or higher education institutions. Currently, 8 states provide a prepaid tuition plan that is accepting new applicants. Those states include Florida, Illinois, Maryland, Massachusetts, Michigan, Nevada, Texas, and Virginia.
Savings Plans – In savings plans, the growth is based upon market performance of the underlying investments, which typically consist of mutual funds. Most of the 529 savings plans offer a variety of age-based asset allocation options where the underlying investments become more conservative as the beneficiary gets closer to college age. Savings plans are administered by states only. However in most of the states, the administrative services are delegated to a mutual fund company.
Virginia529 College Savings Plan is by far the largest of the 529 plans. Virginia529 is actively managing over $43 billion in total assets and had over 2.2 million active accounts.
How much can you contribute?
The amount of contribution depends on the kind of 529 plan one opts for. i.e. Prepaid tuition plan or College savings plan.
By rule, a state program cannot accept contributions in excess of the anticipated cost of a beneficiary's qualified education expenses. This means for the five year graduation program state would not accept contribution more than five years of tuition, fees, and room and board at the costliest college under the plan
As a result, most states have contribution limits of $300,000 and raise their limits each year to keep up with rising college costs. For example, if the state's limit is $300,000, you can't contribute more than $300,000 in a prepaid plan. On the other hand, in college savings plan the state limits the value of the account for a beneficiary. This means that when the value of the account (including contributions and investment earnings) reaches the state’s limit, no more contributions will be accepted. For example, assume the state's limit is $300,000. If you contribute $250,000 and the account has $50,000 of earnings, you won't be able to contribute anymore--the total value of the account has reached the $300,000 limit.
These limits are per beneficiary, so if you and your wife each set up an account for your child in the same plan, your combined contributions can't exceed the plan limit. If you have accounts in more than one state, you can ask each plan's administrator if contributions to other plans count against the state's maximum.
Minimum Contribution you can start off with?
Some plans have minimum contribution requirements. The conditions are:-
1. You have to make a minimum opening deposit when you open your account.
2. Each of your contributions has to be at least a certain amount.
3. You have to contribute at least a certain amount every year.
Here are a few other basic rules that apply to most 529 plans:
- Payment done through Cheque, money orders and Credit cards are accepted. One can't contribute stocks, bonds, mutual funds.
- Contributions can be made by anyone (e.g., your parents, siblings, friends). Just because you're the account owner doesn't mean you're the only one who's allowed to contribute to the account.
529 plans are tax-advantaged vehicles. State offers a generous income tax deduction for contributing to its plan. Also, withdrawals from a 529 plan that are used to pay qualified higher education expenses are completely free from income tax and may also be exempt from state income tax.
What if the money is not used for Education?
Money that is not used for qualified higher education expenses are known as non qualified withdrawals. For example, if you take money from your account for medical bills or other necessary expenses, you're still making a nonqualified withdrawal.
These withdrawals don't enjoy tax-favoured treatment. The earnings part of a nonqualified withdrawal will be subject to federal income tax, and the tax will typically be assessed at the account owner's rate, not at the beneficiary's rate. Plus, the earnings part of a nonqualified withdrawal will be subject to a 10 percent federal penalty, and possibly a state penalty too.
Should you invest in 529Plan?
There are about 3 million NRIs living in USA and the population is increasing rapidly. With the increase in the cost of education in states it has become necessity for NRI’s to enrol for one of the 529 Plan. Save money towards an education fund in order to ensure that your children can go to schools is one of the best gift you can give to your children and 529 Plan is one of the best investment tools available in USA for education goal. If you are an NRI, then start now, save tax, choose your underlying investment option and you will be on your way towards saving good amount for your children.
Disclaimer: This particular plan is not available in India and thus the information about it is taken from various websites like Wikipedia. The whole article is written with due care and thorough research. There might be some information which we could have missed and thus we recommend consulting about the same with your advisor before investing.