Back to School: Basics of 529 College Savings Plans

According to the College Board, a bachelor's degree boosts your earning power by an average of more than a million dollars over a lifetime — but to reap that reward, you first have to tackle the rising price of a college degree.

Financial aid, loans and part-time work may help, but there's no substitute for savings — and when it comes to saving for college, a 529 plan is one option to consider.

An Increasingly Popular Choice

According to collegesavings.org, Americans have opened more than 11 million 529 accounts. Here's why:

No federal income tax. Earnings inside a 529 plan aren't subject to federal income tax if withdrawals are made for qualified college expenses.

High contribution limits. While Coverdell Education Savings Accounts only allow $2,000 in annual contributions, many states allow contributions to a 529 plan in excess of $370,000 or more.¹ Coverdells by mutual funds will no longer be available after June 2012. Brokerage Coverdells will still be available.

Anyone can contribute. Unlike many other tax-advantaged savings accounts, 529 plans don't cut you out of the picture if your income exceeds certain limits. There are also no age limits.

Parental control. When you own a 529 account and name your child the beneficiary, you never lose control of the money. You can even change the beneficiary to another child or yourself if you want to go back to school.

Financial aid-friendly. When applying for federal financial aid, parent-owned 529 plans are currently considered parental assets, which means only 5.6% of the balance is counted each year in the federal aid formula, unlike child assets, which can count against them.

Choosing a 529 Plan

529 plans are sponsored by individual states and you can invest in any state's plan. However, state tax treatment varies by state. Here's what to look for:

State tax benefits. If your home state provides additional tax benefits like a state income tax deduction for contributions you may want to purchase one of your state's plans. If not, you may find a more attractive plan elsewhere.

Set your investments to automatically adjust. As college draws closer, your investments should become more conservative. Some plans offer simple, age-based investment options that automatically shift your money into less risky assets as college gets near.

Free money. Some plans also include a loyalty program that lets merchants contribute to your account when you buy gas, dine out or go shopping.

Toys ... or Tuition?

You don't have to be an account owner to contribute to a 529 plan — once it's open, anyone can chip in. This flexibility opens the door to a smart college savings strategy: letting friends and family know that, instead of trying to pick out the right toy or clothing for a child's birthday present, they can give the simple and powerful gift of education.