529 College Savings Plans: What You Need to Know

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College graduationBy Mandi Woodruff

College tuition rates are heading nowhere but up these days, leaving parents and students more reliant on state-funded financial aid and student loans to finance higher education.

What might be the most accessible and simplest way to save for college -- a 529 savings plan -- is also one of the most widely misunderstood financial tools among consumers, according to a new survey by financial services firm Edward Jones.

Out of more than 1,000 respondents, more than 60 percent couldn't identify the plan as a college savings tool. Even more troubling was the fact that nearly half of respondents with children that could actually benefit from the plan drew blanks.

A 529 plan isn't the only answer to soaring tuition costs, but from the looks of this survey, consumers are sorely in need of a refresher. Here's what you need to know:

What it is: In short, a 529 plan is a tax-free savings fund that can be set up for anyone heading to college. There are two main types: A prepaid tuition plan (the only kind higher education institutions can offer) and a savings fund, according to the College Savings Plan Network. Head over to CSPN's site to try their handy tool to compare the benefits of various plan features.

Who can open one: Put frankly, anyone in the country can open a savings plan in anyone else's name -- from your niece or nephew to your best friend's kid. There's no limit to how many plans you can open, either and you can even change the beneficiary whenever you want.

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How it's funded: Each state offers at least one form of a 529 savings plan (see a full list here), but a lot of doubt has been cast on whether governments would be able to meet demand from cash-strapped consumers in the wake of the recession.

However, a recent report by the College Savings Association showed plans were successfully funded at a rate of 93 percent in 2011–up by 2 percent from the prior fiscal year–which is more than plenty to meet demand. Not everyone investing in plans necessarily taps into them at the same time.

Why you want one: The best perk of 529 plans is the ability to to pay for a host of college-related expenses, including tuition, room and board, books, computer equipment, and even Internet access, all tax-free (the plan student has to be enrolled in school to qualify for the computer and Internet perks, though).

The catch: There are limits to your contributions. Generally, you can put as much cash into the fund as the beneficiary needs to meet college expenses, which will take careful budgeting to figure out (use your school's tuition calculator as a gauge). Keep in mind any contributions that exceed $13,000 in a given year might incur a federal gift tax.

7 PHOTOS
Private Colleges With the Lowest Student Graduating Debt
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529 College Savings Plans: What You Need to Know

Location: Princeton, N.J.

Undergraduate Enrollment: 5,220

Total Annual Cost: $50,269

Average Debt at Graduation: $5,225

Students Who Borrow: 23%

Princeton’s no-loan financial aid policy, introduced a decade ago, means that less than one-fourth of students need to borrow, and the amount they do borrow is small. Princeton’s average debt at graduation, at a little over $5,000, is the lowest among our top 200 private colleges.

Location: Berea, Ky. 

Undergraduate Enrollment: 1,613 

Total Annual Cost: $32,894 

Average Debt at Graduation: $5,836 

Students Who Borrow: 73% 

Plenty of colleges talk about keeping costs, and student debt, down, but Berea walks the walk: This Christian-focused institution covers the full $25,500 tuition for all students, out of a mix of grants and scholarships, leaving them to cover only $7,394 in remaining costs (including room and board). It’s no surprise that average debt here is second-lowest on our list.

Location: Williamstown, Mass. 

Undergraduate Enrollment: 2,029 

Total Annual Cost: $55,360 

Average Debt at Graduation: $8,369 

Students Who Borrow: 43% 

With an average financial-aid package of about $40,000 a year, Williams brings the annual cost of its elite education to a relatively modest $15,360 for students who qualify. Williams admits students without considering their financial circumstances and meets the full demonstrated need of students who enroll.

Location: New Haven, Conn. 

Undergraduate Enrollment: 5,294 

Total Annual Cost: $53,700 

Average Debt at Graduation: $9,254 

Students Who Borrow: 28% 

An Ivy League school with a walloping endowment and a financial-aid budget of $117 million, Yale offers no-loan financial aid to more than half its students, including families earning well over $100,000. Result: Students who borrow carry away one-third less debt than the national average for borrowers at private schools.

Location: Claremont, Cal. 

Undergraduate Enrollment: 956 

Total Annual Cost: $55,700 

Average Debt at Graduation: $9,435 

Students Who Borrow: 36% 

This tiny, all-women’s school awards generous need-based and merit-based grants as well as privately funded need-based loans, which do not accrue interest while the student is in school. (Students also have access to federally sponsored loans, such as Staffords.) Scripps is one of the three members of the Claremont Colleges (a consortium of five colleges and two graduate programs that share faculty and facilities) to make our top ten for low debt.

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Don't be afraid to shop around. Just because your state offers its own 529 plan doesn't mean you can't sniff around for better offers in other states. Students aren't required to attend college in the state where their plan is funded. MorningStar's interactive state-by-state map is a great way to compare plans.

They're not for everyone: Before deciding to invest in a 529 plan, seeking advice from a financial planner or tax consultant would be a wise choice. Basically, treat them like you would enrolling in a company retirement plan. The IRS and the College Savings Plan Network both offer helpful starter guides as well, which will give you talking points to cover.

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