A 529 plan is a tax-advantaged investment plan designed to encourage families to save for future college expenses. The plans, named after Section 529 of the Internal Revenue Code, are operated by states, private sector partners and educational institutions. The two different types of 529 plans are prepaid tuition plans and college savings plans. Under both plans, funds grow income-tax free and, when withdrawn, are exempt from federal income taxes if used for qualifying higher education expenses. If withdrawn funds are not used for higher education expenses, they are subject to federal income taxes plus a 10 percent penalty on earnings.
Texas’ first prepaid tuition plan, which is constitutionally backed, stopped accepting new enrollees in 2003, but still has active participants who expect to use their plan to fund their college education. In 2008, Texas created a new prepaid tuition plan, the Texas Tuition Promise Fund, to replace the previous plan. The new plan places the risk on colleges and universities, not on the state. Public institutions must accept prepaid tuition credits even if the value of the credits is less than current tuition prices. Texas is the only state to structure their prepaid tuition plan in such a way.