Tax-Preferred College Savings Plans: An Introduction to 529 Plans (CRS Report for Congress)
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| Release Date |
Revised Feb. 27, 2024 |
| Report Number |
R42807 |
| Report Type |
Report |
| Authors |
Margot L. Crandall-Hollick, Analyst in Public Finance |
| Source Agency |
Congressional Research Service |
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Summary:
Among the options families may choose to save for education (elementary and secondary as well as higher education), they may consider using tax-advantaged qualified tuition programs (QTPs), also known as 529 plans.
529 plans, named for the section of the tax code which dictates their tax treatment, are tax-advantaged investment trusts used to pay for education expenses. The specific tax advantage of a 529 plan is that distributions (i.e., withdrawals) from this savings plan are tax-free if they are used to pay for qualified higher-education expenses. In addition, up to $10,000 per beneficiary per year can be withdrawn and used for qualifying K-12 education expenses. If some or all of the distribution is used to pay for nonqualified expenses, then a portion of the distribution is taxable, and may also be subject to a 10% penalty tax.
There are two types of 529 plans: "prepaid" plans and "savings" plans. A 529 prepaid plan allows a contributor (i.e., a parent, grandparent, or nonrelative) to make lump-sum or periodic payments that entitle the beneficiary to a specified number of academic periods, course units, or a percentage of tuition costs at current prices. A 529 savings plan allows contributors to invest in a portfolio of mutual funds or other underlying investments.
While prepaid 529 plans were the first type of 529 plan established, savings plans have grown in popularity and are now the most common type of 529 plan. There are currently 18 prepaid 529 plans offered in contrast to 90 savings plans. In addition, according to the most recent data, of the $275.1 billion worth of assets in 529 plans at the end of 2016, 91.8% ($252.6 billion) were held in savings plans, while 8.2% ($22.5 billion) were held in prepaid plans.
This report provides an overview of the mechanics of 529 plans and examines the specific tax advantages of these plans. Specifically, this report is structured to first compare "savings" and "prepaid" 529 plans and, second, to examine the income and gift tax treatment of 529 plans, using a stylized example to illustrate key concepts. The report also examines the tax treatment of rollovers and the interaction of 529 plans with other education tax benefits and looks at how 529 plans are treated in the federal needs analysis for financial aid. Finally, the report summarizes recent permanent legislative changes made by the 2017 tax revision (P.L. 115-97) that allows up to $10,000 to be withdrawn from 529 savings accounts tax-free if used for qualifying K-12 expenses. (The 2017 tax revision was titled the Tax Cuts and Jobs Act (TCJA) before the name was removed prior to final passage of the legislation in the Senate.)
