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Advantages of 529 College Savings Plans over Prepaid Tuition Plans

A Section 529 savings plan is, in many regards, an investment account. Although states may establish the rules, most of these state-sponsored plans are actually administered by mutual fund companies, or fund managers.

Having a fund manager in charge of your money has many benefits, including the fact that these companies hire investment professionals, who you hope will wring a better return out of your money than the state will.

Section 529 savings plans offer several advantages over their prepaid tuition relatives.

  • Maximum allowable account size is usually far greater, between $200,000 and $300,000 per designated beneficiary (depending on the state in which you are investing and adjusted periodically as tuitions and other expenses rise).

  • The value of the plan is counted as an asset of the owner, not the student, when applying for federal financial aid. When applying for financial aid, if the plan owner isn’t either the parent or the child, the amount of money in the plan isn’t included at all in the federal financial aid formula; it may, however, be counted in other formulas the colleges use to determine additional need-based financial aid awards.

  • Distributions from Section 529 savings plans can be used for all qualified higher educational expenses, not just tuition.

  • When planning how much to contribute to your Section 529 plan, you don’t need to project costs only for undergraduate school; these plans can be used to pay for graduate schools, as well.

  • If your savings haven’t produced any earnings at all (your plan is worth less than the amount you put into it when you begin to take distributions), you may claim a loss on your income tax return in the year in which you finally fully distribute the plan.

    When the amount you have been able to distribute over the years is less than the total of your contributions (your basis), you may deduct the difference between your cost and the amount distributed as a miscellaneous itemized deduction on Schedule A of your Form 1040. This provision adds insult to injury: Not only has your investment lost money, but your deduction will be reduced by 2 percent of your adjusted gross income.

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