Glossary of 529 Terms

Illustration for 529 Plan Basics

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529 Plan

This is a type of savings plan that offers unique tax benefits, such as investment returns that are allowed to grow free from federal (and often state) income tax. Three types of this account exist: education savings plans (sometimes called college savings plans), prepaid tuition plans, and ABLE accounts.

Although the federal government first created the concept behind 529 plans, each state administers its own 529 program, so the details vary by location. In most cases, anyone in the U.S. can sign up for whichever 529 plan they want, not just those available from their home state, though many states offer tax breaks to residents who invest in their plan.

The funds in a 529 plan can grow significantly over time, but they can only be used to cover certain costs (“qualified distributions”). Depending on the type of plan, these distributions could be limited to only tuition and fees or could include expenses like room and board or even books and computers. With the passage of the Tax Cuts and Jobs Act of 2017, some 529 plans can also be used to pay for private elementary or secondary education as well as things like apprenticeships or trade school.

A

ABLE/529A Account

As one of the three types of 529 plans, the ABLE account (also called a 529A account) carries many of the same benefits as an education savings plan or prepaid tuition plan, but with one important distinction: it’s intended to help Americans living with disabilities cover essential costs.

In many ways, it operates like an education savings plan, allowing account owners to invest funds that grow tax-free, provided they go toward a qualified expense. However, ABLE accounts offer far more flexibility; the beneficiary of one of these accounts can use their funds on health care costs, housing, and even job training. Plus, the first $100,000 in an ABLE account won’t factor into a person’s Social Security Insurance eligibility, so account owners don’t need to worry about the account limiting their income

Account Maintenance Fee

As a type of administrative fee, the account maintenance fee is used to cover the cost of overseeing the 529 program in which you are enrolled. Typically, these fees are based on a percentage of the assets in the account – generally a fraction of a percentage point per year. Not all plans carry a maintenance or administration fee, however, and among those that do, the higher fees tend to come with advisor-sold plans, rather than those sold directly by the state.

Account Owner

The account owner of a 529 plan is the person in charge of the account. Most often, this is the parent or guardian of the beneficiary, though anyone can open an account on another’s behalf (or their own). The account owner is responsible for deciding how money in the account is invested, if it’s an education savings plan or ABLE account, or for making the required contributions to a prepaid tuition plan.

At any time, there can only be one account owner for a particular plan, though you can usually specify a secondary owner who would take over administration of the plan in the event you pass away. In some states, only the account owner can claim a tax benefit, even in cases where a relative makes a contribution.

Actively Managed Funds

In the world of personal finance, an actively managed fund is one that is overseen and directed by an account manager or management team as opposed to one that simply follows a market index. As a result, these funds have the potential to perform better or worse than the index, and the active involvement of fund managers means that they carry higher fees than passively managed funds.

Advisor-Sold Plan

This is one of two types of 529 plan, the other being direct-sold plans. Advisor-sold plans are those offered by a financial firm and overseen by an advisor who provides investment services. Because of the added support account owners get with an advisor-sold plan, fees are typically higher than with direct-sold plans, but there are often more investment options as well.

Age-Based Portfolio

The investment portfolios available through any education savings plan or ABLE account (but not prepaid tuition plans) always take one of two forms: a static portfolio or an age-based portfolio. The latter is a type of automated investment option in which the allocation of funds changes over time as the beneficiary ages.

When the child is very young, investments tend to be aggressive, with the potential to generate greater returns and a higher level of risk. As they get older and closer to college, the investments in an age-based portfolio become gradually more conservative to preserve any gains. This strategy is a good choice for those with less experience investing or who don’t want to have to constantly manage their plan as the years go by.

Age of Majority

This is the age at which a child becomes a legal adult. In most places across the United States, this age is 18, but some states place it as high as age 21.

Asset-Based Expense

For those with 529 plans, fees play a big role in determining how well a plan performs, and one common way those fees are represented is as an asset-based expense. Typically, the fees associated with a plan come as a percentage of the account’s balance, with more expensive assets – such as actively managed funds – leading to higher fees overall. The actual amount you may be charged varies from state to state, however; some plans, especially direct-sold plans, have very low asset-based expenses, while others charge as much as one or two percent.

B

Beneficiary

The person for whom an account will be used is the beneficiary. Each 529 plan can only have one beneficiary, but this person can be changed at any time. Most often, the beneficiary of a 529 plan is a child, but anyone can be named the beneficiary of one of these plans.

C

College Savings Plan

This is a commonly used name for 529 plans, especially education savings plans (see below). With the passage of the Tax Cuts and Jobs Act in 2017, these plans can be used for private secondary schools or elementary schools as well as trade schools, apprenticeships, or student loans. As a result, they became known by the more general name “education savings plans.”

Custodial Account

This is a type of financial account in which the assets benefit one person – typically a minor – but are managed by another. While the beneficiary is below the age of majority, they have no control over how the funds are used or invested, but once they come of age, they gain full control over the assets in the account. Common examples of custodial accounts include Uniform Gift to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) accounts, though certain 529 plans can also share these characteristics.

D

Direct-Sold Plan

When a plan is provided by the state directly, rather than through a financial advisor, it’s known as a direct-sold plan. These 529 accounts tend to come with lower fees, but the trade-off is that they don’t feature the kind of financial advice and support you’d see with an advisor-sold plan. Direct-sold plans may also come with fewer investment options compared to their counterparts

E

Education Savings Plan

This is the most popular type of 529 plan, largely because it’s also the most flexible. Education savings plans can be used to cover a wide variety of expenses associated with higher education, including tuition, fees, books, equipment, and room and board, which is why they were once called “college savings plans.”

In more recent years, their acceptable uses have expanded to encompass private secondary or elementary school, trade school, or apprenticeships; even student loans are now covered by education savings plans, though only up to a certain amount. Education savings plans also make it easy to use your funds at virtually any accredited college or university. Almost every state offers a type of education savings plan, and many offer more than one.

Enrollment Fee

Also called an application fee, this is the cost of signing up for a particular 529 plan. Depending on the program, you may not have to pay an enrollment fee at all, and those that do carry some type of fee typically charge fairly little – often in the neighborhood of $25 or $50. In some cases, the enrollment fee is lowered if you sign up online, are a resident of the state where the plan is administered, or are opening the plan for a new child.

Estate/Estate Tax

When an individual passes away, the assets they leave behind are referred to as their estate, and this pool of funds, investments, and property is subject to the federal estate tax if its total value exceeds a certain threshold. Depending on the size of the estate, the tax rate could be as high as 40% or as low as 18%.

For many, 529 plans offer an excellent way to shield a portion of a person’s assets from the estate tax. Any funds contributed to a 529 plan are no longer considered part of a person’s estate, but as the account owner, that person would still retain control over the funds. It should be noted, however, that the IRS may still consider 529 plan contributions when levying the estate tax if those contributions were made in the last five years or so.

Expected Family Contribution (EFC)

When considering an application for federal financial aid, the government calculates the applicant’s expected family contribution (EFC) to determine need. Applicants whose family has a greater store of assets may not receive as much as those whose families are expected to have little income to put toward college.

When making this calculation, all sources of income are considered, but not always to the same degree. For instance, a 529 plan owned by a parent will only contribute 5.64% of its value to a student’s EFC, whereas one owned by a grandparent could add 50% of its balance, greatly reducing a student’s eligibility for federal financial aid.

F

Family Member

For the purposes of a 529 plan, only certain relatives are classified as family members by the IRS, and the distinction can be an important one. If an account owner wants to change the beneficiary of their 529 plan, they can do so without penalty, but only so long as the new beneficiary is recognized as a family member from a tax standpoint. Relatives who fall into this classification comprise the following (and their respective spouses):

  • A spouse
  • A descendant, whether biological or adopted
  • A niece or nephew
  • A first cousin
  • A parent, stepparent, or grandparent
  • A father- or mother-in-law
  • A sibling
  • An aunt or uncle

Free Application for Federal Student Aid (FAFSA)

The most commonly used source of financial aid for college students is the federal government, and to apply for these funds, a student or their family must submit a Free Application for Federal Student Aid (more commonly known as FAFSA).

Submitting a FAFSA requires providing a number of documents showing a family’s financial situation, after which the government will calculate that student’s expected family contribution (EFC) to determine their level of need. Having a 529 plan can sometimes factor into this calculation, but accounts owned by a parent have little effect on federal aid considerations.

G

Gift Tax

Any time one person gives something of value to another without the expectation of equally valuable compensation, including a contribution to a 529 plan, that exchange is considered a gift for tax purposes and may incur the federal gift tax. Up to a certain limit – which changes every few years to adjust for inflation – anyone can gift assets to another without having to pay the tax, but values exceeding the federal limit (which is $15,000 in 2021) may force the giver to file a gift tax return with the IRS and possibly pay a portion of the gift in taxes.

However, there’s an important caveat that makes the gift tax a moot point for many families: the lifetime gift tax exemption. Each taxpayer is allowed to exceed the gift tax exemption by a total of more than $11 million over the course of their lifetime, and it’s only after that exemption has been exceeded that the taxpayer must make an actual payment to the IRS.

Glide Path

When making an investment designed to change over time, the term “glide path” is used to describe the trajectory of those changes. With the age-based portfolio in a 529 plan, the glide path declines, meaning that the investment moves from a more aggressive approach to a more conservative one as the target date – typically the point where the beneficiary heads off to college - approaches. Other funds feature a static glide path, meaning that the asset allocation remains the same over time, and some have a rising glide path, indicating a gradually more aggressive investment strategy.

Guaranteed

There are two instances in which you might come across the term “guaranteed” in relation to 529 plans, and it’s important to distinguish between them.

The first refers to the promise a state makes to cover the full cost of tuition, provided you make adequate contributions to your plan. In essence, it’s a guarantee that whatever you pay toward tuition today will grow at a fast enough rate to cover the cost of tuition in the future; should a plan with one of these guarantees fall short, the state will then make up the difference. This type of guarantee applies predominantly to certain prepaid tuition plans, though Pennsylvania has a savings plan that comes with a similar promise.

The second instance in which you might see the term “guaranteed” is with regards to a particular investment portfolio. When making most types of investments, there is an inherent level of risk that you could lose a portion of your funds if the market takes a turn for the worse. When you invest in a guaranteed portfolio, however, the idea is that your investment is protected from loss. The trade-off with a guaranteed investment is that the lower risk comes with a lower rate of return, so you’re unlikely to see much in the way of earnings with one of these portfolios.

I

Investment Change

After setting the initial allocation of funds when opening a 529 plan, the account owner can reallocate those funds through an investment change at any time, but federal law sets a limit on those changes at two per year.

That said, there is a workaround that many account owners find useful: Changing the beneficiary of the plan allows you to change investments as well, and that reallocation does not factor into the normal two-per-year limit. In addition, account owners can change how investments are made going forward – without moving existing funds from one portfolio to another – at any time and as frequently as they wish.

M

Maximum Contribution

Each 529 plan places a limit on how large the balance of an account can grow before contributions must be stopped, which is referred to as the maximum contribution. Depending on the state, this limit can be higher or lower, though it’s always in the hundreds of thousands of dollars. Once it has been reached, you can no longer make contributions to the account, though the balance can still continue to grow.

Minimum Contribution

This term refers to the minimum amount that an account owner must deposit into a 529 plan, either initially (when first opening the plan) or when making subsequent contributions. In most cases, the minimum contribution for a 529 plan is very small – generally no more than $50 – and a number of plans have no minimum whatsoever. However, a few plans carry minimum initial contributions in the thousands of dollars, so be sure to check this particular detail when considering a new 529 plan.

N

Non-Qualified Distributions

Any use of 529 funds other than those specified by the plan (namely, education-related expenses) is treated as a non-qualified distribution. Although an account owner can make one of these distributions at any time, doing so comes with a penalty: that owner will have to pay federal – and likely state – income tax on any earnings they spend, plus a 10% penalty.

P

Passively Managed Funds

When making an investment, some funds are actively managed by one or more financial professionals, while others are not. This second category of assets – passively managed funds – follow the market index, performing at a more or less average level. The benefit of one of these funds is that it carries lower fees, since it’s not constantly being overseen by an individual or firm, and these funds tend to be less risky as well.

Prepaid Tuition Plan

One of the three types of 529 plans is the prepaid tuition plan. The purpose of this account is essentially to lock in today’s price of tuition and avoid the inevitable increases in college costs over the coming years. However, they are less flexible than other kinds of 529 plans and feature a relatively rigid, contract-based structure.

Instead of depositing funds into a financial account the way you would with an education savings plan or ABLE account, the owner of a prepaid tuition plan buys credits at a rate set by the state administering the plan, which generally corresponds to the cost per credit at a public college or university in that state. Contributions are then made at regular intervals in amounts set down in a contract.

Though useful, the only expenses these plans generally cover are tuition and mandatory fees, meaning that you can’t use a prepaid tuition plan to pay for room and board, books, or other college essentials.

Program Manager

Although 529 plans are created and administered by the state, the management of funds in each account is typically turned over to a financial firm. These are the entities that oversee the investment of funds and attempt to provide the highest possible rates of returns, generally in exchange for a small portion of the assets in the account via program management fees.

Program Management Fee

This is the expense passed on to account owners to cover the services of the financial firms that manage investments for a particular 529 plan or the government agencies that administer the plan. Typically, this fee is a small fraction of a percent – though it varies from state to state – and a few 529 plans have no program management fee at all.

Q

Qualified Distribution

This is the term for the accepted uses of funds from a 529 plan. Depending on the type of plan, the list of qualified distributions could be short or long; for prepaid tuition plans, only tuition and fees count as qualified distributions, whereas education savings plans cover housing, books, and equipment as well.

In addition to the basic college costs considered qualified distributions, account owners may also be able to use their 529 plan for private school – both elementary and secondary – up to a certain limit. Other qualified distributions from 529 plans include the cost of an apprenticeship, trade/vocational school, or student loans (also up to a limit).

Qualified Tuition Program

This is the technical name for a 529 plan and the one used by the Internal Revenue Service on their website. It is a type of qualified education program.

R

Residency Requirement

Most 529 plans are open to enrollment by all U.S. residents, no matter what state they live in, but a few impose restrictions on who can sign up. In some cases, the account owner or beneficiary must be a resident of the state, as with the Florida 529 Savings Plan, but the exact nature of the residency requirement can differ from one state to the next.

Rollover

The term “rollover” refers to the act of moving funds from one 529 plan to another, and there are two different types: direct rollovers and indirect rollovers. Most states treat rollovers differently than regular contributions for tax purposes.

Direct rollovers are those handled by the administrator of the 529 plan. They will be the ones to move the funds from the old account to the new one; all the account owner needs to do is fill out the appropriate form and (depending on the plan) secure a medallion signature guarantee.

Indirect rollovers are those that the account owner handles themselves. To make this change, the owner would need to withdraw the funds from the account and place them into a new 529 plan within 60 days; otherwise, the transaction would be considered a non-qualified distribution and be subject to income tax and a 10% penalty. In addition, the account owner must specify which portion of the funds is contributions and which is earnings, and transferring funds from one plan to another from the same state is typically treated as an investment change, not a rollover.

S

Section 529

Created in 1996, this provision of the Internal Revenue Code lays out the basic traits of 529 plans, including what federal tax advantages they enjoy, and is the source of the plans’ name.

Static Portfolio

When opening a 529 plan, account owners must choose which of the two types of portfolios they want to invest in: an age-based portfolio or a static portfolio. The latter of the two, static portfolios, are those determined entirely by the account owner, with minimal involvement or changes made on the part of the plan administrator or advisor.

Unlike age-based portfolios, which shift allocations automatically over time, static portfolios don’t change unless the account owner does so themselves, making them a better option for those who have experience managing investments. Most plans also offer far more options for static portfolios than for age-based ones, and many allow for customized investments in a mix of funds determined by the account owner.

T

Tax Credit

This is one of the common varieties of tax breaks given to people and businesses. Generally, tax credits work by applying a percentage of some amount you’ve already paid – either toward a 529 plan, a foreign tax obligation, or some other expense – toward the amount you owe the IRS in taxes. While most of the tax breaks offered for 529 plan contributions take the form of a deduction, some states offer an income tax credit instead.

Tax Deduction

This is one of the most common types of tax breaks offered to individuals and businesses. When you claim a tax deduction, you reduce your tax burden by lowering your total taxable income for the year, causing the IRS to calculate your obligation based on a smaller number and possibly even moving you into a different tax bracket. Many states offer an income tax deduction for contributions to 529 plans, though the rules on claiming these deductions vary by state.