The 529 Plan
The 529 Plan (named after its section number in the IRS code) is a savings plan for college education. You have a couple of options when you open an account.
  • One option lets you prepay tuition at a qualified educational institution at today's tuition rates (see below).
  • Another option lets you save money in a tax-deferred account (earnings only) to be used to pay for education at future tuition rates.
The idea, with either option, is that the investment earnings will grow to meet the higher costs of future education. The savings account option is typically considered the more attractive of the two and is what we will focus on in this article.

The 529 plan is a state-sponsored investment program. That is, the state sets up the plan with an asset management company of its choice, and you open a 529 account with that asset management company according to the state's predetermined plan features. You are the owner of the account, and the child for whom the account is set up is the beneficiary. You won't deal directly with the state, but rather with the asset management/investment company.

Because each state can control some of the features of its own plan, there are variations from state to state. Most plans follow the same general scheme (and federal requirements), but make sure you compare plans among states other than your own. Most states don't require residency in order to participate, so shop around different states for the best deal. Click here for information that will help you compare states and choose the right plan.

In the next section, we'll look at some of the things that make the 529 plan so attractive.

Prepaid Tuition Option
With the prepaid tuition option, parents, grandparents and anyone else can lock in todays tuition rates, and the program will pay future college tuition at any of the states eligible colleges or universities. The program will also pay an equal amount of money to private or out-of-state institutions.

You will usually deal directly with a state agency when setting up a prepaid tuition plan. You buy tuition units (or years) either with a one-time lump sum purchase or monthly installments. If you opt for the prepaid route, then that money is pooled with other prepaid sums from other account owners and invested by the program in order to grow to meet (or even exceed) future tuition needs.

The prepaid tuition account also works differently in regard to eligibility for financial aid. The money paid out from the prepaid tuition 529 account offsets the eligibility for financial aid dollar-for-dollar. In other words, if your prepaid tuition account pays $10,000 for tuition one year, then your child will be seen as needing $10,000 less for financial aid.