The SEC’s Office of Investor Education and Advocacy is issuing this Investor Bulletin to provide investors with background information on 529 plans. Please also see our companion Bulletin for a few questions to consider before opening a 529 plan account.
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: prepaid 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 prepaid tuition plan.
What are the differences between prepaid tuition plans and college savings plans?
Prepaid Tuition Plans. Prepaid tuition plans let a college saver or account holder purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and mandatory fees at current prices for the beneficiary. Prepaid tuition plans usually cannot be used to pay for future room and board.
Most prepaid tuition plans are sponsored by state governments and have residency requirements for the college saver and/or beneficiary. Prepaid plans are not guaranteed by the federal government. Some state governments guarantee the money paid into the prepaid tuition plans that they sponsor, but some do not. If your prepaid tuition payments aren’t guaranteed, you may lose some or all of your money in the plan if the plan’s sponsor has a financial shortfall. In addition, if a beneficiary doesn’t attend a participating college or university, the prepaid tuition plan may pay less than if the beneficiary attended a participating college or university. It may only pay a small return on the original investment.
College Savings Plans. College savings plans let a college saver open an investment account to save for the beneficiary’s future qualified higher education expenses – tuition, mandatory fees and room and board. Withdrawals from college savings plan accounts can generally be used at any college or university, including sometimes at non-U.S. colleges and universities. A college saver may typically choose among a range of investment portfolio options, which often include various mutual fund and exchange-traded fund (ETF) portfolios and a principal-protected bank product. These portfolios also may include static fund portfolios and age-based portfolios (sometimes called target-date portfolios). Age-based portfolios automatically shift toward more conservative investments as the beneficiary gets closer to college age.
All college savings plans are sponsored by state governments, but only a few have residency requirements for the college saver and/or beneficiary. State governments do not guarantee investments in college savings plans. College savings plan investments in mutual funds and ETFs are not federally guaranteed, but investments in some principal-protected bank products may be insured by the FDIC. Similar to most investments, investments in college savings plans may not make any money and could lose some or all of the money invested.
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 529 plan (college savings plan or prepaid tuition plan), whether it is a broker- or direct-sold plan, the plan itself and the underlying investments. You should carefully review the plan’s offering circular to understand what fees are charged for the plan and each investment option.
Prepaid Tuition Plans. Prepaid tuition plans may charge an enrollment/application fee and ongoing administrative fees.
College Savings Plans. College savings plans may charge an enrollment/application fee, annual account maintenance fees, ongoing program management fees, and ongoing asset management fees. Some of these fees are collected by the state sponsor of the plan and some are collected by the plan manager. The asset management fees will depend on the investment option you select. Investors that purchase a college savings plan from a broker are typically subject to additional fees, such as sales loads or charges at the time of investment or redemption and ongoing distribution fees.
Fee Saving Tips. Many states offer direct-sold college savings plans in which college savers can invest without paying additional broker-charged fees. In addition, some college savings plans will waive or reduce the administrative or maintenance fees if you maintain a large account balance, participate in an automatic contribution plan, or are a resident of the state sponsoring the 529 plan. Some 529 plans also offer fee waivers if the college saver accepts electronic-only delivery of documents or enrolls online.
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. You should make sure you understand the tax implications of investing in a 529 plan and consider whether to consult a tax adviser.
Contributions. Many states offer tax benefits for contributions to a 529 plan. These benefits may include deducting contributions from state income tax or matching grants. But college savers may only be eligible for these benefits if you invest in a 529 plan sponsored by your state of residence.
Withdrawals. If you use 529 account withdrawals for qualified higher education expenses, earnings in the 529 account are not subject to federal income tax and, in most cases, state income tax. However, if 529 account withdrawals are not used for qualified higher education expenses, they will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings.
What restrictions apply to an investment in a 529 plan?
There will likely be restrictions on 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 restrictions.
Investments. College savings plans have certain pre-set investment options. It is not permitted to switch freely among the options. Under current tax law, an account holder is only permitted to change his or her investment option twice per year or when there is a change in the beneficiary.
Withdrawals. With limited exceptions, you can only withdraw money that you invest in a college savings plan for qualified higher education expenses without incurring taxes and penalties. Beneficiaries of prepaid tuition plans may only use their purchased credits or units at participating colleges or universities. If a beneficiary doesn’t attend a participating college or university, the prepaid tuition plan may pay less than if the beneficiary attended a participating college or university. It may only pay a small return on the original investment.
Does investing in a 529 plan impact financial aid eligibility?
While each educational institution may treat assets held in a 529 account differently, investing in a 529 plan will generally impact a student’s eligibility to receive need-based financial aid. For many families, the larger part of a financial aid package may be in loans. So, the more you can save before college, the less debt you or your student may have to incur during college.
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. The National Association of State Treasurers created the College Savings Plan Network, which provides links to most 529 plan websites.
529 Expense Analyzer. 529 college savings plans have fees and expenses that can vary widely from plan to plan. The Financial Industry Regulatory Authority (FINRA) has developed a tool to help you compare how these fees and expenses can reduce returns.
Underlying Mutual Funds or Exchange-Traded Funds. Additional information about a mutual fund or ETF that is an investment option in a college savings plan is available in its prospectus, statement of additional information, and semiannual and annual shareholder reports. You can obtain these documents from the plan manager for no charge. You can also review these documents on the SEC’s EDGAR database.
Fees and Expenses. You can read about the impact fees and expenses have on your investment portfolios in the SEC’s Office of Investor Education and Advocacy’s Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio.
Brokers or Investment Advisers. Many college savings plans’ program managers are registered investment advisers. You can search for an investment adviser and view its Form ADV on Investor.gov. You can also search for any disciplinary sanctions against a broker who may sell a 529 savings plan product, as well as information about his or her professional background and registration and licensing status, on Investor.gov.
Financial Aid. You can read more about federal financial aid at the U.S. Department of Education’s Federal Student Aid website.
Other Online Resources. You can learn more about 529 plans and other college saving options on FINRA’s Saving for College website. The website contains links to other sites, including the College Savings Plan Network and the Internal Revenue Service’s Publication 970 (Tax Benefits for Higher Education). You can also find educational information about 529 plans on the Municipal Securities Rulemaking Board’s education center website.
The Office of Investor Education and Advocacy has provided this information as a service to investors. It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the meaning or application of a particular law or rule, please consult with an attorney who specializes in securities or tax law.