AN INTRODUCTION TO 529 PLANS - PART 2
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. Earnings in 529 plans are not subject to federal tax, and in most cases, state tax, so long as you use withdrawals for eligible college expenses, such as tuition and room and board. However, if you withdraw money from a 529 plan and do not use it on an eligible college expense, you generally will be subject to income tax and an additional 10% federal tax penalty on earnings.
Many 529 plans also offer additional state tax benefits. Some states allow residents to deduct contributions to 529 plans from income tax returns for the state that sponsors the plan, but most still limit state tax benefits to participation in a 529 plan sponsored by your state of residence. Some states also offer matching grants or other additional benefits, typically to low income investors.
If you receive state tax benefits for investing in a 529 plan, make sure you review your plan’s offering circular before you complete a transaction, such as rolling money out of your home state’s plan into another state’s plan. Some transactions may have state tax consequences for residents of certain states.
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 plan. Prepaid tuition plans typically charge enrollment and administrative fees. In addition to “loads” for broker-sold plans, college savings plans may charge enrollment fees, annual maintenance fees, and asset management fees. Some of these fees are collected by the state sponsor of the plan, and some are collected by the financial services firms that the state sponsor typically hires to manage its 529 program. Some college savings plans will waive or reduce some of these fees if you maintain a large account balance or participate in an automatic contribution plan, or if you are a resident of the state sponsoring the 529 plan. Your asset management fees will depend on the investment option you select. Each investment option will typically bear a portfolio-weighted average of the fees and expenses of the mutual funds and other investments in which it invests. You should carefully review the fees of the underlying investments because they are likely to be different for each investment option.
Investors that purchase a college savings plan from a broker are typically subject to additional fees. If you invest in a broker-sold plan, you may pay a “load.” Broadly speaking, the load is paid to your broker as a commission for selling the college savings plan to you. Broker-sold plans also charge an annual distribution fee (similar to the “12b 1 fee” charged by some mutual funds) of between 0.25% and 1.00% of your investment. Your broker typically receives all or most of these annual distribution fees for selling your 529 plan to you. Many broker-sold 529 plans offer more than one class of shares, which impose different fees and expenses.
Trans World Assurance makes available the information and services contained herein in furtherance of Trans World Assurance's goal to inform and educate. While Trans World Assurance makes every effort to present accurate and reliable information on this site, Trans World Assurance does not endorse, approve or certify such information, nor does Trans World Assurance guarantee the accuracy, completeness, efficacy, or timeliness of such information. Trans World Assurance assumes no responsibility for consequences resulting from use of the information contained herein, or from use of the information obtained at linked sites, or in any respect for the content of such information.