What is a 529 Plan?

Other than the obvious benefit of setting aside money for education expenses, 529 plans provide other excellent benefits.

Although money invested in a 529 plan is not tax deductible, any growth and income produced from inception is never taxed if used for higher education expenses.

It is important to know that the person who opens the account is usually the named owner and the child is named as beneficiary. Therefore, the owner is free to change the named beneficiary if the child-beneficiary does not attend college or does not use the full amount in the account.

Even though the money in a 529 account is controlled by the “owner,” it is not considered to be part of the owner’s estate. This factor creates estate-planning opportunities for certain persons, and some states offer a state income tax deduction for their residents. This can be a significant factor to weigh, along with the rankings.

The investment choices available in 529 plans vary from plan to plan. Some are self-directed, allowing the owner to choose how the money is divided among a group of mutual funds; some do all the investing with no input from the owner; some offer investments geared to the age of the beneficiary; and some offer a combination of these choices.

•The age-weighted choice simply means that the plan will invest the funds in a set but changing way over time. For very young beneficiaries, investments are oriented more to equities for long-term growth. For older beneficiaries, with a shorter time horizon, investments would be less aggressive. The investments in age-weighted plans become all fixed-income and liquid when the funds are needed for college expenses. This choice may be best for those who start late whose beneficiary is already in high school. For younger beneficiaries, and for owners who have other sources of money to augment the 529 plan, a self-directed choice may be better.

•The self-directed approach, when available, provides a great deal of flexibility, but requires more careful attention. The plan usually offers a group of different mutual funds from which to choose. The owner who chooses too aggressive an asset allocation can be whipsawed.

Timing is everything — for example, with the recent downturn in the financial markets some high-quality investments were depressed. In that case, some parent-owners chose not to use 529 plan monies but to pay for some college expenses out of earned income, leaving the equity investments in the 529 plan to recover for a year or two.

Owners who know how to manage their investments and/or have an investment adviser will feel more comfortable with this choice. As with all investing, asset allocation will determine investment performance over time. And it will be important for the owner to change that asset allocation as the beneficiary nears college age, when investments in the plan are gradually liquidated to provide needed cash.

Keep in mind that the entire plan will not need to be liquidated for the first year of college. This still leaves the balance in the plan to continue growing, on a tax-free basis.

Owners with other sources of cash for college will have more choices.

529 plans are hard to beat for all their benefits. Some are opened with a gift from a relative like a grandparent, aunt or uncle. A check sent to the plan, once opened, then makes Christmas and birthday giving even easier and more satisfying for those folks rather than expensive gadgets and toys.