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How 529 Plans Work


The 529 Plan
Multiple 529 plans give you multiple ways to save for your child's myriad college expenses.
Multiple 529 plans give you multiple ways to save for your child's myriad college expenses.
Ariel Skelley/Getty Images

The 529 Plan (named for Section 529 of the IRS tax code) is a savings plan for college education. There are two types of 529 plan:

  • One option lets you prepay tuition at a qualified educational institution at current tuition rates.
  • The other option lets you invest money in a tax-deferred account that will later be used to pay for education at future tuition rates.

Either option lets you earn interest on your investment. Pre-paid tuition plans have some serious drawbacks, mainly because they're more restrictive with who can participate and how the money can be used. For that reason, we're going to focus this article on the more flexible 529 investment plans.

A 529 plan is a state-sponsored investment program. That is, the state sets up the plan with an asset management company of its choice, and you open a 529 account with that asset management company according to the state's predetermined plan features. You're the owner of the account, and the child for whom the account is set up is the beneficiary. You won't deal directly with the state, but rather with the asset management/investment company. Like any other investment, a 529 is subject to market risk – the state doesn't guarantee your money.

How do 529 plans vary from state to state? Find out next.