A dual college-saving and tax-avoiding option known as a 529 plan is growing in popularity, new research shows, but remains unknown to many.
In the past five years, 2 million additional families have opened 529 plans, college savings accounts that allow money to accumulate and be withdrawn federally tax-free when put to use on education-related expenses. According to Financial Research Corporation (FRC), 5.5 million households in the United States have 529 plans in 2012, up from 3.5 million five years ago.
"Awareness has been rapidly increasing over the relative short term," writes Paul Curley, FRC's director of college savings research, in an E-mail to U.S. News. "FRC projects the number to expand as more families learn and understand the importance of saving for education."
[Find out how to pay for college.]
Still, many don't know about the option, named for Section 529 in the Internal Revenue Code under which it was created. In a recent survey released by financial consulting firm Edward Jones, 62 percent of about 1,000 parents did not know what a 529 plan was.
"The findings were concerning, to be sure," says Greg Dosmann, a principal partner at Edward Jones. "That's our challenge in the industry: Help Americans understand that [a 529 plan] is a very viable tax advantage savings tool to help them save for their children's education."
[Learn about other overlooked ways to pay for college.]
Simply knowing what a 529 plan is may not be enough to help you determine what account is right for you and your beneficiary. There's also the challenge of understanding all the aspects of the plans, notes Marcos Cordero, who serves as chief gradsaver at GradSave.com, a virtual way to open 529 plans that allow family and friends to donate directly, too.
There are two types of 529 plans: prepaid tuition and college savings plans. Between the two, there are more than 100 individual options to choose from, which can vary in terms of requirements and eligibility.
Often, investors can take out an account in any state or the District of Columbia, regardless of where they reside, but evaluating your own state's plan is a good first bet. You may be eligible for additional state tax benefits, and some states, including Louisiana and Colorado, even match a percentage of money squirreled away by parents.
In addition, 529 plans are either direct- or broker-sold, depending on whether the account owner wants to invest on his or her own or with the help of a financial adviser. Both routes offer benefits and disadvantages, according to savingforcollege.com, a directory of 529 plans. Some broker-sold plans may be more expensive, GradSave.com's Cordero notes.
But no matter the plan, "it's always going to be a smart option because of the tax benefits," Cordero says. "Basically, Uncle Sam is 'paying' parents to save for college ... That's really powerful."
529 plans are also unique in the flexibility they allow account holders, Dosmann of Edward Jones notes. The owner (who does not have to be a parent) remains in control of the account when the beneficiary becomes an adult, and can transfer it to another beneficiary.
Therefore, if a college savings account turns out to be redundant for one child (given scholarships and merit aid awarded, for instance, or if the original beneficiary decides to forego college) the account can be kicked to, say, a younger child or a parent who is going back to school.
Given that flexibility, parents can open a 529 plan without forecasting the education future for a very young child. In fact, the ideal time to start an account for a child is "the day they're born–or sooner," Dosmann says.
Many families wait a few years, FRC's Curley notes. According to the firm's research, about 34 percent of 529 plans are started by parents whose children are between 5 and 10 years old. Starting early gives your account time to grow, and allows investors to experiment with aggressive funds before gradually shifting toward conservative options as their children near college age.