by Richard S. Schwartz, CPA, CVA

For most people, three of the largest expenses they will incur in their lifetime are buying a house, saving for retirement, and paying for a child’s college education. Buying a home is generally done via a mortgage to make it affordable for the everyday person. Saving for retirement is also done over a period of many years, usually via an employer sponsored retirement plan such as a 401(k) or 403(b) plan or via IRA?s. Similarly, one also has the option to save for a child?s college education utilizing a long term plan as well.

The IRS allows individuals to save for a child?s education via a tax- free plan called a Section 529 Plan. Each state sponsors their own plan in connection with an investment company such as Fidelity, Vanguard, or Schwab among others.

Individuals generally choose a plan based upon the investment objectives and track record of each specific state plan. For instance, you may live in Massachusetts (the MA sponsored plan is managed by Fidelity Investments), but can choose to use another state?s college savings plan. While many states do offer an incentive to their residents to use their own state sponsored plan by offering a tax deduction on their state income tax return, other states, including MA, do not offer such a tax break.

529 Plans are usually categorized as either prepaid plans or savings plans.

  • Prepaid Plans allow individuals to prepay, or ?lock in? all or part of the costs of an in-state public college in today?s dollars for their children, grandchildren, etc. These plans may also be converted for use at an out-of state college or a private college. (More info on a national prepaid plan is available at
  • Savings Plans allow individuals to make contributions into a pre-set portfolio of mutual funds for their children, grandchildren etc. The goal of these funds is long-term growth in the value of the portfolio. These accounts will fluctuate in value based upon the underlying investment portfolio of the plan.

For both plans, contribution limits are subject to tax free gifting rules. For 2010, you and your spouse can jointly gift up to $26,000 per year per child without gift tax consequences. However, special rules allow taxpayers to front-load five years of gifts into one year for education planning, allowing you and your spouse to jointly gift up to $130,000 into the plan in any one year during a five year time period. Please note that you will need to file a gift tax return if you’re married and contribute more than $26k on behalf of one child in any calendar year.

The primary advantage of 529 Plans are as follows:

  • Although the contributions to the plan are not tax deductible on your federal tax return, the plan?s earnings grow tax-deferred.
  • Distributions used for tuition and other qualified expenses are tax-free to you and the beneficiary (child).
  • Control of the funds remains with the donor (parent or grandparent, etc.) Contributing to a section 529 plan is a revocable gift ? thus, the donor can take the funds back (subject to taxes and a penalty of 10% on the earnings) or reassign the funds to another child’s 529 account.
  • The plans investments are professionally managed, utilizing the expertise of investment portfolio managers of national investment companies.
  • Individuals can instruct the plan to automatically invest the funds monthly/periodically via an electronic funds transfer from your checking account to the plan in order to take advantage of the benefits of dollar cost averaging for investment purposes.

In summary, we are all well aware of the already exorbitant and continually growing costs associated with attending a college or university. For this reason, you need to start saving for a child’s college education as soon as you can, hopefully while your child is relatively young.

As part of your planning process, as with any investment decision, you should consult an expert and/or do your research. Start by contacting the various investment companies? toll free customer service phone numbers to discuss your questions with their representatives, or visit their websites and read through their literature; both avenues provide a wealth of knowledge of general information for Section 529 Plans as well as specific information pertaining to their own plan(s). Another great resource is the website which provides an abundance of useful information on Section 529 Plans and also maintains rankings of the performance of the different state sponsored plans.