In my post yesterday, I mentioned 529 Plans as a great tool to save for college.  I thought I would expound on them a bit today.

A 529 Plan is a investment account in the United States  that allows you to save for college in a tax-advantaged manner. You get to save money for the education expenses of a specific person, called the beneficiary. The plan is named after section 529 of the US Internal Revenue Code.

Each state has its own plan, with significant differences from state to state, but because of the underlying federal legislation, they all have quite a few things in common.

Two Plans

The first thing you should know is that there are actually two types of plans; a pre-paid one and an investment one.

• The pre-paid plan is basically what it sounds like; you pay the current tuition now, and when they go to school, the bill has been paid. In other words, you are paying future expenses with current dollars.  Generally, this is not a good idea. Besides, the problem for most people is they don’t have the money to pay for college; thus, they need to save for it.

• The investment plan is based on investment options in the account, usually mutual funds. Most plans offer quite a few options, both equity and debt based (stock funds and bond funds). You can typically move the money within the account from fund to fund as your needs change. The inner workings (as far as the owner are concerned ) are a lot like your 401K at work; there is the Growth fund, the Aggressive Growth fund, the Risk Free (savings) fund and so on.

The investment plan is best for most folks. While it is administered by the state, the day to day operation is typically out-sourced to a mutual fund company. You are not required to use the plan offered by the state you live in but there may be tax advantages to doing so; do your research or ask your adviser.

Pros and Cons

Pros:

• All growth is income tax free (both state and federal).
• Beneficiary can be changed to another family member.
• Most states do not tax withdrawals as long as they are used for education.
• Withdrawals can pay for tuition, fees, dorm expense, books and almost any educational expense.
• Very High Contribution Limits
• A very attractive estate planning vehicle for those who qualify.
• 529 Plans offer some bankruptcy protection.
• Very low minimum monthly contribution limits, putting it in the range of most budgets

Cons:

The only real con is that some states have outrageous fees. You can use this website to find out the details of your state’s plan and can use it to compare the fees. In fact, sometimes the excessive fees are a good enough reason to abandon your state’s plan in favor of another, even disregarding the tax benefits you get from staying in state.