| Be careful when investing in Class B shares. If the beneficiary uses the money within a few years after purchasing Class B shares, you will almost always pay a contingent deferred sales charge or load in addition to higher annual fees and expenses. |
|
An Introduction to 529 Plans
What is a 529 plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college
costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state
agencies, or educational institutions and are authorized by Section 529 of the Internal
Revenue Code.
There are two types of 529 plans:
pre-paid tuition plans and college
savings plans. All fifty states and
the District of Columbia sponsor at
least one type of 529 plan. In
addition, a group of private colleges
and universities sponsor a pre-paid
tuition plan.
What are the differences between
pre-paid tuition plans and college
savings plans?
Pre-paid tuition plans generally allow
college savers to purchase units or credits at participating colleges and universities for future
tuition and, in some cases, room and board. Most prepaid tuition plans are sponsored by state
governments and have residency requirements. Many state governments guarantee
investments in pre-paid tuition plans that they sponsor.
College savings plans generally permit a college saver (also called the “account holder”) to
establish an account for a student (the “beneficiary”) for the purpose of paying the beneficiary’
s eligible college expenses. An account holder may typically choose among several investment
options for his or her contributions, which the college savings plan invests on behalf of the
account holder. Investment options often include stock mutual funds, bond mutual funds, and
money market funds, as well as, age-based portfolios that automatically shift toward more
conservative investments as the beneficiary gets closer to college age. Withdrawals from
college savings plans can generally be used at any college or university. Investments in
college savings plans that invest in mutual funds are not guaranteed by state governments
and are not federally insured.
The following chart outlines some of the major differences between pre-paid tuition plans and
college savings plans.1
1 Source: Smart Saving for College, FINRA®
How does investing in a 529 plan affect federal and state income taxes?
Investing in a 529 plan may offer college savers special tax benefits. Earnings in 529 plans are
not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for
eligible college expenses, such as tuition and room and board.
However, if you withdraw money from a 529 plan and do not use it on an eligible college
expense, you generally will be subject to income tax and an additional 10% federal tax penalty
on earnings. Many states offer state income tax or other benefits, such as matching grants, for
investing in a 529 plan. But you may only be eligible for these benefits if you participate in a
529 plan sponsored by your state of residence. Just a few states allow residents to deduct
contributions to any 529 plan from state income tax returns.
If you receive state tax benefits for investing in a 529 plan, make sure you review your plan’s
offering circular before you complete a transaction, such as rolling money out of your home
state’s plan into another state’s plan. Some transactions may have state tax consequences for
residents of certain states.
What fees and expenses will I pay if I invest in a 529 plan?
It is important to understand the fees and expenses associated with 529 plans because they
lower your returns. Fees and expenses will vary based on the type of plan. Prepaid tuition
plans typically charge enrollment and administrative fees. In addition to “loads” for broker-sold
plans, college savings plans may charge enrollment fees, annual maintenance fees, and asset
management fees. Some of these fees are collected by the state sponsor of the plan, and
some are collected by the financial services firms that the state sponsor typically hires to
manage its 529 program. Some college savings plans will waive or reduce some of these fees
if you maintain a large account balance or participate in an automatic contribution plan, or if
you are a resident of the state sponsoring the 529 plan. Your asset management fees will
depend on the investment option you select. Each investment option will typically bear a
portfolio-weighted average of the fees and expenses of the mutual funds and other
investments in which it invests. You should carefully review the fees of the underlying
investments because they are likely to be different for each investment option.
Investors that purchase a college savings plan from a broker are typically subject to additional
fees. If you invest in a broker-sold plan, you may pay a “load.” Broadly speaking, the load is
paid to your broker as a commission for selling the college savings plan to you. Broker-sold
plans also charge an annual distribution fee (similar to the “12b 1 fee” charged by some
mutual funds) of between 0.25% and 1.00% of your investment. Your broker typically receives
all or most of these annual distribution fees for selling your 529 plan to you.
Many broker-sold 529 plans offer more than one class of shares, which impose different fees
and expenses. Here are some key characteristics of the most common 529 plan share classes
sold by brokers to their customers:
Is there any way to purchase a 529 plan but avoid some of the extra fees?
Direct-Sold College Savings Plans. States offer college savings plans through which residents
and, in many cases, non-residents can invest without paying a "load," or sales fee. This type
of plan, which you can buy directly from the plan's sponsor or program manager without the
assistance of a broker, is generally less expensive because it waives or does not charge sales
fees that may apply to broker-sold plans. You can generally find information on a direct-sold
plan by contacting the plan’s sponsor or program manager or visiting the plan’s website.
Websites such as the one maintained by the College Savings Plan Network, as well as a
number of commercial websites, provide links to most 529 plan websites.
Broker-Sold College Savings Plans. If you prefer to purchase a broker-sold plan, you may be
able to reduce the front-end load for purchasing Class A shares if you invest or plan to invest
above certain threshold amounts. Ask your broker how to qualify for these “breakpoint
discounts.”
What restrictions apply to an investment in a 529 plan?
Withdrawal restrictions apply to both college savings plans and pre-paid tuition plans. With
limited exceptions, you can only withdraw money that you invest in a 529 plan for eligible
college expenses without incurring taxes and penalties. In addition, participants in college
savings plans have limited investment options and are not permitted to switch freely among
available investment options. Under current tax law, an account holder is only permitted to
change his or her investment option one time per year. Additional limitations will likely apply to
any 529 plan you may be considering. Before you invest in a 529 plan, you should read the
plan’s offering circular to make sure that you understand and are comfortable with any plan
limitations.
Does investing in a 529 plan impact financial aid eligibility?
While each educational institution may treat assets held in a 529 plan differently, investing in a
529 plan will generally reduce a student’s eligibility to participate in need-based financial aid.
Beginning July 1, 2006, assets held in pre-paid tuition plans and college savings plans will be
treated similarly for federal financial aid purposes. Both will be treated as parental assets in the
calculation of the expected family contribution toward college costs. Previously, benefits from
pre-paid tuition plans were not treated as parental assets and typically reduced need-based
financial aid on a dollar for dollar basis, while assets held in college savings plans received
more favorable financial aid treatment.
Is investing in a 529 plan right for me?
Before you start saving specifically for college, you should consider your overall financial
situation. Instead of saving for college, you may want to focus on other financial goals like
buying a home, saving for retirement, or paying off high interest credit card bills. Remember
that you may face penalties or lose benefits if you do not use the money in a 529 account for
higher education expenses. If you decide that saving specifically for college is right for you,
then the next step is to determine whether investing in a 529 plan is your best college saving
option. Investing in a 529 plan is only one of several ways to save for college. Other tax-
advantaged ways to save for college include Coverdell education savings accounts, Uniform
Gifts to Minors Act (“UGMA”) accounts, Uniform Transfers to Minors Act (“UTMA”) accounts, tax-
exempt municipal securities, and savings bonds. Saving for college in a taxable account is
another option.
Each college saving option has advantages and disadvantages, and may have a different
impact on your eligibility for financial aid, so you should evaluate each option carefully. If you
need help determining which options work best for your circumstances, you should consult with
your financial professional or tax advisor before you start saving.
What questions should I ask before I invest in a 529 plan?
Knowing the answers to these questions may help you decide which 529 plan is best for you.
Is the plan available directly from the state or plan sponsor?
What fees are charged by the plan? How much of my investment goes to compensating my
broker? Under what circumstances does the plan waive or reduce certain fees?
What are the plan’s withdrawal restrictions? What types of college expenses are covered by
the plan? Which colleges and universities participate in the plan?
What types of investment options are offered by the plan? How long are contributions held
before being invested?
Does the plan offer special benefits for state residents? Would I be better off investing in my
state’s plan or another plan? Does my state’s plan offer tax advantages or other benefits for
investment in the plan it sponsors? If my state’s plan charges higher fees than another state’s
plan, do the tax advantages or other benefits offered by my state outweigh the benefit of
investing in another state’s less expensive plan?
What limitations apply to the plan? When can an account holder change investment options,
switch beneficiaries, or transfer ownership of the account to another account holder?
Who is the program manager? When does the program manager’s current management
contract expire? How has the plan performed in the past?
Where can I find more information?
Offering Circulars for 529 Plans. You can find out more about a particular 529 plan by reading
its offering circular. Often called a “disclosure statement,” “disclosure document,” or “program
description,” the offering circular will have detailed information about investment options, tax
benefits and consequences, fees and expenses, financial aid, limitations, risks, and other
specific information relating to the 529 plan. Most 529 plans post their offering circulars on
publicly available websites. The National Association of State Treasurers created the College
Savings Plan Network which provides links to most 529 plan websites.
Additional Information About Underlying Mutual Funds. You may want to find more about a
mutual fund included in a college savings plan investment option. Additional information about
a mutual fund is available in its prospectus, statement of additional information, and
semiannual and annual report. Offering circulars for college savings plans often indicate how
you can obtain these documents from the plan manager for no charge. You can also review
these documents on the SEC’s EDGAR database.
Investment Adviser Public Disclosure Website. Many college savings plans’ program managers
are registered investment advisers. You can find more about investment advisers through the
Investment Adviser Public Disclosure website. On the website, you can search for an
investment adviser and view the Form ADV of the adviser. Form ADV contains information
about an investment adviser and its business operations as well as disclosure about certain
disciplinary events involving the adviser and its key personnel.
http://www.sec.gov/investor/pubs/intro529.htm
What is a 529 plan?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college
costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state
agencies, or educational institutions and are authorized by Section 529 of the Internal
Revenue Code.
There are two types of 529 plans:
pre-paid tuition plans and college
savings plans. All fifty states and
the District of Columbia sponsor at
least one type of 529 plan. In
addition, a group of private colleges
and universities sponsor a pre-paid
tuition plan.
What are the differences between
pre-paid tuition plans and college
savings plans?
Pre-paid tuition plans generally allow
college savers to purchase units or credits at participating colleges and universities for future
tuition and, in some cases, room and board. Most prepaid tuition plans are sponsored by state
governments and have residency requirements. Many state governments guarantee
investments in pre-paid tuition plans that they sponsor.
College savings plans generally permit a college saver (also called the “account holder”) to
establish an account for a student (the “beneficiary”) for the purpose of paying the beneficiary’
s eligible college expenses. An account holder may typically choose among several investment
options for his or her contributions, which the college savings plan invests on behalf of the
account holder. Investment options often include stock mutual funds, bond mutual funds, and
money market funds, as well as, age-based portfolios that automatically shift toward more
conservative investments as the beneficiary gets closer to college age. Withdrawals from
college savings plans can generally be used at any college or university. Investments in
college savings plans that invest in mutual funds are not guaranteed by state governments
and are not federally insured.
The following chart outlines some of the major differences between pre-paid tuition plans and
college savings plans.1
1 Source: Smart Saving for College, FINRA®
How does investing in a 529 plan affect federal and state income taxes?
Investing in a 529 plan may offer college savers special tax benefits. Earnings in 529 plans are
not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for
eligible college expenses, such as tuition and room and board.
However, if you withdraw money from a 529 plan and do not use it on an eligible college
expense, you generally will be subject to income tax and an additional 10% federal tax penalty
on earnings. Many states offer state income tax or other benefits, such as matching grants, for
investing in a 529 plan. But you may only be eligible for these benefits if you participate in a
529 plan sponsored by your state of residence. Just a few states allow residents to deduct
contributions to any 529 plan from state income tax returns.
If you receive state tax benefits for investing in a 529 plan, make sure you review your plan’s
offering circular before you complete a transaction, such as rolling money out of your home
state’s plan into another state’s plan. Some transactions may have state tax consequences for
residents of certain states.
What fees and expenses will I pay if I invest in a 529 plan?
It is important to understand the fees and expenses associated with 529 plans because they
lower your returns. Fees and expenses will vary based on the type of plan. Prepaid tuition
plans typically charge enrollment and administrative fees. In addition to “loads” for broker-sold
plans, college savings plans may charge enrollment fees, annual maintenance fees, and asset
management fees. Some of these fees are collected by the state sponsor of the plan, and
some are collected by the financial services firms that the state sponsor typically hires to
manage its 529 program. Some college savings plans will waive or reduce some of these fees
if you maintain a large account balance or participate in an automatic contribution plan, or if
you are a resident of the state sponsoring the 529 plan. Your asset management fees will
depend on the investment option you select. Each investment option will typically bear a
portfolio-weighted average of the fees and expenses of the mutual funds and other
investments in which it invests. You should carefully review the fees of the underlying
investments because they are likely to be different for each investment option.
Investors that purchase a college savings plan from a broker are typically subject to additional
fees. If you invest in a broker-sold plan, you may pay a “load.” Broadly speaking, the load is
paid to your broker as a commission for selling the college savings plan to you. Broker-sold
plans also charge an annual distribution fee (similar to the “12b 1 fee” charged by some
mutual funds) of between 0.25% and 1.00% of your investment. Your broker typically receives
all or most of these annual distribution fees for selling your 529 plan to you.
Many broker-sold 529 plans offer more than one class of shares, which impose different fees
and expenses. Here are some key characteristics of the most common 529 plan share classes
sold by brokers to their customers:
- Class A shares typically impose a front-end sales load. Front-end sales loads reduce
the amount of your investment. For example, let’s say you have $1,000 and want to
invest in a college savings plan with a 5% front-end load. The $50 sales load you must
pay is deducted from your $1,000, and the remaining $950 is invested in the college
savings plan. Class A shares usually have a lower annual distribution fee and lower
overall annual expenses than other 529 share classes. In addition, your front-end load
may be reduced if you invest above certain threshold amounts – this is known as a
breakpoint discount. These discounts do not apply to investments in Class B or Class C
shares.
- Class B shares typically do not have a front-end sales load. Instead, they may charge a
fee when you withdraw money from an investment option, known as a deferred sales
charge or “back-end load.” A common back-end load is the “contingent deferred sales
charge” or “contingent deferred sales load” (also known as a “CDSC” or “CDSL”). The
amount of this load will depend on how long you hold your investment and typically
decreases to zero if you hold your investment long enough. Class B shares typically
impose a higher annual distribution fee and higher overall annual expenses than Class
A shares. Class B shares usually convert automatically to Class A shares if you hold
your shares long enough.
- Class C shares might have an annual distribution fee, other annual expenses, and
either a front- or back-end sales load. But the front- or back-end load for Class C shares
tends to be lower than for Class A or Class B shares, respectively. Class C shares
typically impose a higher annual distribution fee and higher overall annual expenses
than Class A shares, but, unlike Class B shares, generally do not convert to another
class over time. If you are a long-term investor, Class C shares may be more expensive
than investing in Class A or Class B shares.
Is there any way to purchase a 529 plan but avoid some of the extra fees?
Direct-Sold College Savings Plans. States offer college savings plans through which residents
and, in many cases, non-residents can invest without paying a "load," or sales fee. This type
of plan, which you can buy directly from the plan's sponsor or program manager without the
assistance of a broker, is generally less expensive because it waives or does not charge sales
fees that may apply to broker-sold plans. You can generally find information on a direct-sold
plan by contacting the plan’s sponsor or program manager or visiting the plan’s website.
Websites such as the one maintained by the College Savings Plan Network, as well as a
number of commercial websites, provide links to most 529 plan websites.
Broker-Sold College Savings Plans. If you prefer to purchase a broker-sold plan, you may be
able to reduce the front-end load for purchasing Class A shares if you invest or plan to invest
above certain threshold amounts. Ask your broker how to qualify for these “breakpoint
discounts.”
What restrictions apply to an investment in a 529 plan?
Withdrawal restrictions apply to both college savings plans and pre-paid tuition plans. With
limited exceptions, you can only withdraw money that you invest in a 529 plan for eligible
college expenses without incurring taxes and penalties. In addition, participants in college
savings plans have limited investment options and are not permitted to switch freely among
available investment options. Under current tax law, an account holder is only permitted to
change his or her investment option one time per year. Additional limitations will likely apply to
any 529 plan you may be considering. Before you invest in a 529 plan, you should read the
plan’s offering circular to make sure that you understand and are comfortable with any plan
limitations.
Does investing in a 529 plan impact financial aid eligibility?
While each educational institution may treat assets held in a 529 plan differently, investing in a
529 plan will generally reduce a student’s eligibility to participate in need-based financial aid.
Beginning July 1, 2006, assets held in pre-paid tuition plans and college savings plans will be
treated similarly for federal financial aid purposes. Both will be treated as parental assets in the
calculation of the expected family contribution toward college costs. Previously, benefits from
pre-paid tuition plans were not treated as parental assets and typically reduced need-based
financial aid on a dollar for dollar basis, while assets held in college savings plans received
more favorable financial aid treatment.
Is investing in a 529 plan right for me?
Before you start saving specifically for college, you should consider your overall financial
situation. Instead of saving for college, you may want to focus on other financial goals like
buying a home, saving for retirement, or paying off high interest credit card bills. Remember
that you may face penalties or lose benefits if you do not use the money in a 529 account for
higher education expenses. If you decide that saving specifically for college is right for you,
then the next step is to determine whether investing in a 529 plan is your best college saving
option. Investing in a 529 plan is only one of several ways to save for college. Other tax-
advantaged ways to save for college include Coverdell education savings accounts, Uniform
Gifts to Minors Act (“UGMA”) accounts, Uniform Transfers to Minors Act (“UTMA”) accounts, tax-
exempt municipal securities, and savings bonds. Saving for college in a taxable account is
another option.
Each college saving option has advantages and disadvantages, and may have a different
impact on your eligibility for financial aid, so you should evaluate each option carefully. If you
need help determining which options work best for your circumstances, you should consult with
your financial professional or tax advisor before you start saving.
What questions should I ask before I invest in a 529 plan?
Knowing the answers to these questions may help you decide which 529 plan is best for you.
Is the plan available directly from the state or plan sponsor?
What fees are charged by the plan? How much of my investment goes to compensating my
broker? Under what circumstances does the plan waive or reduce certain fees?
What are the plan’s withdrawal restrictions? What types of college expenses are covered by
the plan? Which colleges and universities participate in the plan?
What types of investment options are offered by the plan? How long are contributions held
before being invested?
Does the plan offer special benefits for state residents? Would I be better off investing in my
state’s plan or another plan? Does my state’s plan offer tax advantages or other benefits for
investment in the plan it sponsors? If my state’s plan charges higher fees than another state’s
plan, do the tax advantages or other benefits offered by my state outweigh the benefit of
investing in another state’s less expensive plan?
What limitations apply to the plan? When can an account holder change investment options,
switch beneficiaries, or transfer ownership of the account to another account holder?
Who is the program manager? When does the program manager’s current management
contract expire? How has the plan performed in the past?
Where can I find more information?
Offering Circulars for 529 Plans. You can find out more about a particular 529 plan by reading
its offering circular. Often called a “disclosure statement,” “disclosure document,” or “program
description,” the offering circular will have detailed information about investment options, tax
benefits and consequences, fees and expenses, financial aid, limitations, risks, and other
specific information relating to the 529 plan. Most 529 plans post their offering circulars on
publicly available websites. The National Association of State Treasurers created the College
Savings Plan Network which provides links to most 529 plan websites.
Additional Information About Underlying Mutual Funds. You may want to find more about a
mutual fund included in a college savings plan investment option. Additional information about
a mutual fund is available in its prospectus, statement of additional information, and
semiannual and annual report. Offering circulars for college savings plans often indicate how
you can obtain these documents from the plan manager for no charge. You can also review
these documents on the SEC’s EDGAR database.
Investment Adviser Public Disclosure Website. Many college savings plans’ program managers
are registered investment advisers. You can find more about investment advisers through the
Investment Adviser Public Disclosure website. On the website, you can search for an
investment adviser and view the Form ADV of the adviser. Form ADV contains information
about an investment adviser and its business operations as well as disclosure about certain
disciplinary events involving the adviser and its key personnel.
http://www.sec.gov/investor/pubs/intro529.htm
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