What you need to know about 529s

There’s no denying that a college education can come with a hefty price tag. According to statistics from the US Department of Education, the average annual rates for undergraduate tuition, room and board are $16,757 at public schools, $23,776 at private, for-profit universities and $43,065 at private nonprofit institutions. In fact, a study conducted by The College Board concluded that tuition and fees have increased beyond the cost of inflation, a trend that has continued for more than 30 years.

One of the safest options for setting aside money in order to pay for higher education (or post-secondary training) is the 529 plan, a college savings plan created by Congress in 1996, legally known as a “qualified tuition plan.” Its name derives from the Section 529 of the Internal Revenue Code, since every state sponsors at least one type of plan.

There are numerous advantages to using a 529. Here’s an overview of the top four benefits.

Unlike other popular savings accounts, when it’s time to withdraw your funds for qualified higher education expenses—such as tuition, books, computers, room and board—your earnings will not be subject to federal tax and, in some cases, state tax. Also, the longer your money is invested in a 529 plan, the greater your tax benefits will be on your tax-free earnings. However, if this money is used for anything other than qualified higher education costs or tuition for elementary or secondary schools, you will be hit with a federal and state tax bill, along with a 10 percent federal tax penalty on earnings.

While many parents are concerned that having a substantial amount of funds in savings will reduce their odds of getting financial aid, a 529 plan is deemed a parental asset. Therefore, that asset is factored, at a maximum of 5.6 percent, into a financial aid formula determined by the government. It's considerably less than the estimated 20 percent rate that is calculated when applying with funds from other types of accounts.

Most states have contribution limits, which range from $300,000 to $380,000 on average per plan. While plans vary from state to state, contributions made to a 529 savings plan in one state is usually not factored into the maximum lifetime contribution from a 529 plan in another state. It’s important to note that contributions can be made in cash; checks, money orders or credit cards are also acceptable. If you wish to contribute with earnings made from other investments, like stocks or mutual funds, the assets must first be liquidated.

Anyone is allowed to open a 529 plan—there are no income limits and no age restrictions—and anyone can be named as the beneficiary, including your child, grandchild, friend or even yourself, as long as the person has a social security number or tax ID. The name of the beneficiary can be changed at any time with zero tax penalties, as well. What's more, you can open as many plans as you like and funds can be rolled over from one plan to another without being taxed. The person who owns the account (known as the participant or the custodian) manages the money, which ensures that funds cannot be invested, withdrawn or rolled over without their consent.

Also, while each plan is sponsored by a state that works with a financial institution, the beneficiary can usually attend a school in any state that sponsors their 529 plan.

Interested in a 529? Speak with your accountant or financial advisor about it, or the type of college savings account that best suits your needs.