529 Plans for College Expenses: What’s Cool and What’s Quirky


529 plans for college expenses are very cool but extremely quirky. Cool federal-tax benefits, which were temporary and set to expire in just a few years, have been made permanent by The Pension Protection Act of 2006 (USA). The quirkiness and murkiness remains, however, but is made much clearer by the kind folks at Kiplinger.com, who have provided me (and anyone with an Internet connection) with some great resources, discussed here but awaiting your further perusal, beginning with these articles on saving for college and 529 college-savings plans.  

What are 529 plans? They are college savings programs created by individual states as authorized by Section 529 of the Internal Revenue Code. There are two kinds of 529s: prepaid tuition plans and college savings plans.

States sponsor programs and most outsource investment services to third-party firms such as Vanguard or T. Rowe Price. (The outsourcing of investment plans with pre-designed portfolios was a source of confusion and annoyance for me when I first started investigating these programs but the concept is similar to how employers offer 401(k) plans with multiple but finite investment plans that are designed and serviced by outside entities.)

The original intent for Section 529 rule, from what I can glean, was to provide a mechanism to prepay tomorrow’s tuition at today’s rates. Locking in tuition rates at a state-supported college or university (using a prepaid plan), though attractive, is not widely available. According to Kiplinger’s 529 plan locator, only 18 states have prepaid plans (prepaid contracts or prepaid units / guaranteed savings) and, of those, only 5 have "program benefits backed by the full faith and credit of the state” with an additional 5 having other types of guarantees (according to one of the "compare by questions" sections on Kiplinger's site, September 12, 2007).

If you are considering a private college or university, however, there is a prepaid program: Independent 529 Plan sponsored by Tuition Plan Consortium LLC and managed by TIAA-CREF Tuition Financing Inc. According to the plan’s website, contracts with private colleges and universities specify that units bought at a discount today must be honored tomorrow. You can visit its website to view participating institutions.

Though the prepaid programs may not be available for your state or desired institution of higher learning, there are tax benefits that should place investigating, selecting, and funding a 529 Plan on a parents’ to-do list. Before you decide on which program to select, here’s what’s cool and what’s quirky:


  • Earnings (e.g., capital gains, interest, and dividends) grow tax deferred.
  • 529s are treated as parental assets for financial aid purposes.
  • Grandparents (and others) can fund 529 plans with no impact on the student’s financial aid status.
  • If one child doesn’t need any or all of the money, funds can be moved to other 529 accounts; Kiplinger has supplied a list of approved transfers here.
  • Most 529 plans allow you to use funds for expenses at nearly any U.S. college or university.


  • Individual states contract with third parties to manage programs. These firms offer investment options and pre-designed portfolios, some of which are age-based so that the stock/bond ratio converts from heavily weighted with stocks to heavily weighted with bonds as the beneficiary/student gets older and ready to use the money for college. 
  • Some options are offered only through brokers; others are available for direct purchase. You can find either type using Kiplinger's plan locator.
  • You can choose a plan sponsored by your state or you can invest in a plan sponsored by another state, though you will most likely forgo certain benefits (such as state income tax deductions) if you go with an out-of-state plan. 
  • State income tax benefits differ widely and contribution limits vary by state.
  • There may be account maintenance fees (flat fees) and service charges (usually % of assets).
  • You can change plans but usually just once a year.

The real value of the 529 Plan is that withdrawals for qualified educational expenses can be made free of federal income taxes. Remember to make sure that withdrawals don’t exceed qualified expenses as any excess amounts will result in unearned income to the beneficiary (student). And if the money is not used for college, then earnings are taxed at your regular income rate plus 10%, according to The New Math of Paying for College.

Now, that you've decided (most likely) to open a 529, which one should you choose? Kiplinger has state-by-state recommendations with rationale for its recommendations that I found useful.

Here are factors to consider in selecting a plan (each will impact your college cash flow in some way):

  • Availability of pre-paid plans in your home state or for your desired college/university;
  • State income tax benefits;
  • Account maintenance fees and service charges;
  • Potential investment returns.

Though the 529 plans may not offer significant immediate benefits to all U.S. parents, investing now could yield great advantages to your tax bill and cash flow later. As state offerings (investment plans) change, you'll be wise to evaluate plans now and review your choices every year but the time (and money) invested should be worth it.

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Linsey Knerl's picture

Nice overview of the plans... I really appreciate you giving such a spectrum of info on the subject... This is great!

Guest's picture

I was literally just Googling this very topic an hour ago, and very pleased to see your post pop up in Google Reader.

I am looking for a means of starting college funds for my niece (4) and nephew (6mos). However, I expect them both to attend private school for at least high school, and it's my understanding that 529s are only for post-secondary expenses.

Would a combination of an Education Savings Account and 529 make sense, with the former focused on contributing to their pre-college education and the latter for college? Are there any 529 horror stories where people have lost a lot of money? I was looking at Wells Fargo and all their options had positive return rates over several years.

Julie Rains's picture

Thanks for asking about the Coverdell/Education Savings Account and I think it makes sense to use both, depending on your tax situation. I should probably mention that I'm not a CPA/tax expert so it would be helpful to consult such a person but this information should get you going. All of this is made quirkier because of recent tax law changes.  

But, from what I've read you can use a Coverdell to pay for private elementary and secondary schools, even SAT prep courses. And you are likely to get an immediate federal tax benefit as you can claim up to $2,000 in annual deductions. You can also invest in nearly anything you want so you don't have to go with one of the pre-fab investment plans. You're right that 529s are only for college/university study.

As far as horror stories, I haven't heard them but the investment options (or lack thereof) were the main reason I hadn't started a 529 plan yet. I think the investment firms are catching on that they need to do better (as far as fees, investment returns, etc.) and it looks like you can even buy index funds (which seem to be popular with wisebread readers) through some states (Kansas for example when I checked last).

Hope this helps!


Guest's picture

Hi, I just found your site and think it's great; thanks for the information and motivation!

Just a question for you...My husband and I are maxing out our retirement savings, have an emergency fund, and still have some money to invest. We don't yet have kids but are thinking about it in the next ~2 years. We are lucky to have a good income now (which could change of course) and having a tangible goal would make it easier to save more, so we were thinking about pre-saving for our future kids' educations.

The idea would be that we would open 529s for each of us and then when kids come we could transfer them to the kids' names. I can't find any information that says this is not legal, but it just seems too easy or maybe I haven't thought of everything. What do you think?

Julie Rains's picture

It does look like to me that you could open a 529 in your name (or your husband's name) and then change the beneficiary to your child later. I mentioned the account transfer eligibility in the post (here's reference to the column) and it's quite a long list -- you can even make transfers to cousins or parents (I listed this benefit under cool but I think it's quirky as well). It's always a good idea to ask your accountant for verification, but I think you are on the right track.

Guest's picture

I'm no expert, but I performed a reasonable amount of research prior to choosing to combine an ESA ($2K per year) with a 529 ($1K/year).

It appeared to me that an ESA offered tax benefits similar to a 529. Therefore, there were two main differences between the two programs:

1. You cannot contribute more than $2K per year to an ESA, while you can contribute exponentially more to a 529.

2. You can use an ESA for essentially any education-related expense, whereas a 529 can only be used for "approved post-secondary education expenses." Does your high school student need a laptop? The ESA will cover it. You want to send your middle-school kid to a private instituation? The ESA will cover it.

If the 529 could be used for the same purposes as an ESA, then I would invest all $3K per year into a 529. However, as a member of the military, there's a decent chance that I will spend a tour in an area with substandard public education, and I wanted the increased flexibility offered by an ESA.

PS, I'm a Florida resident (no state income tax), so I don't get any of the state tax benefits that others do. That should definitely be a consideration when choosing between an ESA and a 529, or even when choosing among different 529 plans.


Julie Rains's picture

Thanks for your comments Joe. Since you mentioned Florida, it is one of the few states that offers a prepaid tuition plan with state backing. Also, one of the main differences between the Coverdell ESA and the 529 (in addition to the ones you noted) is that the ESA also offers an immediate federal tax deduction whereas the 529 does not. There are some limits to the 529 contributions for some plans but the caps are very high.

Guest's picture

Thanks for a great article, although it probably bears repeating that some state's plans charge outrageous fees for 529's. Here's a good article that mentions some of the State plans to avoid:


Julie Rains's picture

Since you mentioned fees and I only touched on that in the post, here's a resource mentioned by The Motley Fool and other personal finance resources: Saving for College has a list of fees for 529 plans. The site separates the types of fees: 1) enrollment or application fees; 2) maintenance fees; 3) program management fees and 4) expenses of the underlying investments. I find it easier to think of individual fees (and how to avoid them or if these are worth it) to make a decision. If you're going to invest, you will most likely incur some fees: the fees for underlying investments, for example, would be hard to avoid: if you invest in a mutual fund, you'll pay fees and if you trade (purchase and sell individual stocks), you'll have to pay trading fees and all fees will impact the investment growth. So, if you can find a decent plan in your state, it's nice to either avoid some of the fees not charged to residents and take a tax deduction that offsets the fees.