A prepaid state 529 plan prepays tuition at a public school.
A 529 plan, which gets its name from Internal Revenue Code Section 529, is a college savings account. A benefactor of a child, such as a parent or other relative, can set up this plan to save money for the child's future college expenses. According to the University of California, the 529 plan benefactor can even be the same as the recipient. A 529 plan is a type of trust, so the benefactor has control over withdrawals from this account.
State Prepaid Plan
In a prepaid 529 plan, the account will cover the expenses at a specific school or group of schools. A prepaid state 529 plan pays the tuition at a state university. This plan allows the investor to pay tuition several years before the student attends the higher education campus, so the investor often pays a much lower amount for tuition. A prepaid state 529 plan usually allows a student to choose one of several colleges and universities that the state operates.
Independent Prepaid Plan
It can be difficult to transfer the funds in a prepaid 529 account to another school, and the investor may not receive all of the funds. According to Yale University, the amount of fund value which transfers to a school that does not participate in the plan varies by state. An independent prepaid 529 plan pays for tuition at a private school, and this type of plan may allow the student to select one of several hundred participating private universities. Independent prepaid 529 plans are newer than state 529 plans.
Savings Plan
A savings 529 plan is a savings account which can apply to any college or university. When using a state 529 savings plan, there are no penalties if the student decides to go to an out-of-state school or a private school. The savings 529 plan has more flexibility, but it loses the greatest benefit of the prepaid 529 plan: With a savings 529, the investor does not lock in tuition at the current rate.
Gift Taxes
Contributions to a 529 plan are gifts under federal and state law. The investor can deduct the value of gifts from income under state and federal tax law, up to a certain threshold. When the value of the funds in the 529 account increases, these gains are not taxable. Withdrawals from a 529 plan are also not taxable if the student spends this money on qualified educational expenses. If the donor contributes an amount greater than this threshold value to a 529 account in one year, the donor can average the contribution over a period of five years to reduce or eliminate gift tax liability.
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