As you look for ways to invest for college education expenses, you may want to investigate the use of a Qualified Tuition Program, which often is referred to as a 529 Plan.

These plans let you invest larger sums of money than other education savings programs with the advantages of tax-deferred earnings growth and withdrawals free of federal income tax if used to pay for qualified education expenses. You can use a 529 Plan to pay for the education expenses of yourself or other person you select.

How They Work

  • There are two types of 529 Plans - pre-paid tuition plans and savings plans. A pre-paid tuition plan lets you buy credits for education costs. With this plan, you select from a list of schools established by the state. A savings plan allows you to make contributions into an account and build earnings to pay future education costs. You have more choices of schools. The state also selects a financial institution to manage its plan and handle the investment of your contributions.
  • As an account owner, you make contributions and name the person who will use the account for future education expenses. The plan manager invests all account contributions using a pre-arranged and approved strategy. Neither you nor the student you name as beneficiary can control the investments. The account owner can select the initial investment strategy and can change it once per year.
  • When your student is enrolled in a postsecondary education program, funds can be withdrawn to pay for tuition, books, fees and certain living expenses. Postsecondary education generally includes any accredited public or private college degree program and any vocational program approved for federal financial aid. Most state 529 Plans also will cover education programs in other states.

Tax Advantages

A key feature of the 529 Plan is that you and your beneficiary do not pay income taxes each year on the growth of earnings in your account. When you need money for education expenses, earnings on qualified withdrawals are free of federal income tax.

Many states also offer tax deductions to residents if they make contributions into their 529 Plan.

A 529 Plan lets you contribute up to $12,000 per year for each beneficiary's account ($24,000 for spousal gifts) without any gift tax - another significant tax advantage. Federal rules allow you to contribute up to $60,000 per beneficiary in one year ($120,000 for spousal gifts) as long as you spread the contributions for gift purposes over five years on a gift tax return. This can be an appealing feature for high-net worth individuals looking for a way to transfer wealth.

Qualified Withdrawals for Education Expenses

Any 529 Plan withdrawals that are not used for qualified education expenses will face a penalty. However, you may withdraw funds without a penalty if:

  • your student beneficiary receives a scholarship, and the withdrawal is not more than the amount of the scholarship;
  • you withdraw any or all of the funds because of the death or disability of the beneficiary;
  • you complete a rollover of the account to a 529 account for a new beneficiary who is a family member of the prior beneficiary.

While the funds are penalty free, they are subject to federal and state income taxes.

The variety of features offered by a 529 Plan can allow you to accumulate savings for children, grandchildren, other relatives or yourself at a much faster pace than other education savings programs. A 529 Plan may be a valuable option for you to consider in your college savings financial plan.

The availability of tax or other benefits may be conditioned on meeting certain requirements. Non-qualified withdrawals are subject to federal and state income taxes and a 10% penalty.

Before investing, consider the investment objectives, risks, and charges and expenses associated with investing in 529 Plans. More information about 529 Plans is available in the issuer's official statement, and it should be read carefully before investing.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.