The Benefits

Tax Treatment

  • All of the account's earnings are exempt from federal tax when they are withdrawn if they are used for qualified education expenses. This means that, unlike the taxes you have to pay on earnings from regular stock investments, you won't pay any tax on the 529 account earnings unless you end up using the money for something other than higher education. Earnings are currently tax-deferred in most states, as well.

  • A break on the earnings tax isn't the only tax advantage, either. Although your contributions aren't pre-tax (you pay state and federal tax on the money you put into the account), there are some states that let you deduct a portion of your contributions from your state taxes. More states will probably follow suit in the coming years.

The tax exemption on 529 account earnings is in effect at least until 2011, which is when it can revert back to the original plan where the earnings are taxed at the child's rate. It is very likely that Congress will revisit the 529 issue and vote to make the tax-free status permanent prior to that date.

Account Control

  • Unlike custodial accounts or Education Savings Accounts (ESAs, formerly Education IRAs), the beneficiary does not gain control of the money at a specific age (usually 18 or 21 for those types of accounts). The account owner always has control of the money. This helps lessen that parental anxiety that Junior will take the money and tour Europe or buy a Porsche instead of going to college.

  • There are no restrictions on who can open an account for whom. You can open an account for your child, a friend's child, a relative, the paper boy, or even yourself.

  • Anyone can contribute to the account. Now all (or at least some) of that birthday money from Grandma and Grandpa that's usually blown on candy and soon-forgotten toys can be funneled into the college savings account!

Income Eligibility

  • Did you know that with an ESA, you aren't eligible to contribute if you make more than $110,000 per year ($220,000 for married couples)? Unlike ESAs, your income does not affect your eligibility to open a 529 account.

  • Contributions to 529 plans also qualify for the $11,000 ($22,000 for married couples in 2002) annual gift tax exclusion. You can also contribute up to five years of gifts during the first year, meaning you can put in up to $55,000 ($110,000 for married couples). This is a great benefit in situations where inheritance money enters the picture.

  • Your account can grow up to $268,000 in some states.

  • You can contribute as little as $25 to $50 per month.

How the Money Can Be Used

  • In most states, there is no age limit or time limit for when the money has to be used. Your child can put off college indefinitely, in which case you have the option of rolling the account over to another child as long as that child is in the same family of the first beneficiary. In case you're wondering just who is considered "family," the plan defines family members as "the original beneficiary's spouse, children, sisters, brothers, nephews, nieces, first cousins, and any spouses of those persons."

  • Your child can go to any accredited degree-granting educational institution, whether it is public, private, two-year, or four-year. There are even some international schools that qualify.

  • In most states, qualified education costs include tuition, books, room, board, transportation, and even computers.

  • In the event that your child gets a scholarship, then the remainder of the 529 account can be rolled over to another sibling (or relative), or it can be cashed out with no penalty other than the tax paid (at your rate) on the earnings. The same rule applies in the event of the child's death or disability.

Investment Control

  • If the thought of turning over your hard earned money to the state makes you a little uneasy, rest assured that the state doesn't control your money. In fact, most states are signing on with well-known, successful investment companies such as TIAA-CREF, Vanguard and Fidelity. The number and types of investment options vary by state, and once you select your option you can't change it. You can, however, roll your money over into another state's plan if you're not happy with your chosen investment option. There is no penalty to roll the money over into another state's plan, and you can do it once every 12 months. Most states have no residence requirement for their 529 plans.

  • Many plans are also offering investment choices that are age-based. This means that if you're starting early, perhaps when your child is age one to three, the investments can begin aggressively in stocks then gradually shift to bonds and money market accounts as your child gets closer to college age. Some state plans offer several levels of options for aggressive, moderate and conservative investments.

  • If you can't reach the risk level you want in one plan, you can always open a second 529 account in the same or another state. You can have as many accounts as you want and can also contribute to both a 529 plan and an ESA. That way, you can diversify your investments in the event that the plan doesn't offer the investment mix you would like.