Investor Education | Q’s and A’s on Section 529 Plans

Section 529 plans remain a popular way for parents to set aside funds for college education of their children. Here are the answers to several common questions on the subject.

Q. What exactly is a Section 529 plan?

A. A type of educational savings plan generally operated by the individual states. Section 529 plans are designed to encourage families to set aside funds for the future education of the younger generation. If certain requirements are met, no tax is due on the accumulation of earnings, and no tax is due when funds are paid out for qualified distributions.

Q. How does a prepaid tuition plan work?

A. Essentially, the plan keeps pace with the rising cost of college tuition. For instance, it currently costs $10,000 annually to send a child to a state university. You pay $10,000 now to buy shares in a plan. When the child enters college, your shares can pay for an entire year of tuition, no matter what it costs them. This type of plan is often attractive to parents because it offers a level of comfort. There is no risk of loss of principal, and the investment is usually guaranteed by the state.

Q. How does a college savings plan work?

A. As opposed to a prepaid tuition plan, there is no guaranteed lock on future tuition costs under a college savings plan. In fact, the savings may not be enough to cover all the costs. But you have a bigger potential upside as well, because it's possible to generate a better return with this type of plan. (Of course, there are no guarantees, and all investing involves risk, including the possible loss of principal.)

Usually the plan will offer an asset allocation strategy geared to the current age of the child or the year he or she will enter school. For example, the plan may provide more aggressive investments in the early years and switch to more conservative investments as college approaches. Most college savings plans offer a variety of risk-based asset allocation portfolios managed by professionals.

Q. What are the restrictions on contributions?

A. Anyone can contribute to a Section 529 plan on behalf of a named beneficiary. Then, each state sets the limits on the amount of contributions allowed to a college savings plan. Check the limits in your state.

Note: In the event a child decides not to attend college or attends school in another state, you may be able to transfer funds to another plan or "roll over" funds for the benefit of a successor beneficiary (e.g., a younger child). This type of plan is suitable for many, but is not for everyone. Investigate the options carefully to see if a Section 529 plan meets your family's personal needs.

Before investing, the investor should consider whether the investor's or beneficiary's home state offers any state tax or other benefits available only from that state's 529 plan.

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