Since its creation under the Small Business Job Protection Act of 1996, the Section 529 plan has become much more popular than other education-saving vehicles such as education savings bonds and the Coverdell Education Savings Account. However, despite its popularity, there is still confusion, which has led some people to establish the wrong type of 529 plan. DMG Financial Advisors will listen to the factors that will help you choose the plan that's right for you.
Two Types of 529 Plans
Before choosing a 529 plan, be aware of the two major types: the college savings plan and the prepaid tuition program.
College Savings Plan
Under a college savings plan, amounts are contributed up to the dollar limit of the plan. Investors may be allowed to choose the investments from a list provided by the plan manager. In some college savings plans, the investment options are age based, with the most risky investments made available to younger individuals. Since the investor bears the risks of the investments, the amount that is eventually available for eligible education expenses will be affected by the rate of return on the investments.
The assets in a college savings plan may be used to cover eligible expenses at any eligible educational institution.
Prepaid Tuition Program
Under a prepaid tuition program, eligible expenses for a fixed period of time or a fixed number of credits are prepaid at an eligible educational institution. For example, an individual may make prepayments for two future semesters of college at today's cost. The prepayment guarantees the beneficiary two semesters, regardless of the cost in the future. This means that the program manager bears the risks of the investments. Contributions are limited to amounts necessary to pay the beneficiary's qualified education expenses.
Unlike the assets in the college savings plan, which can be used to pay qualified expenses at any eligible educational institution, assets in a prepaid tuition program are usually used toward expenses at a predetermined educational institution, or an educational institution from a predetermined list. Should the beneficiary decide to attend an educational institution that is not included in the predetermined list, the current market value of the prepayments may not be sufficient to cover the cost of comparable tuition at the other educational institution. This means that the beneficiary may need to cover the difference out of pocket.