What Is A 529 Plan And Is It Right For Me?
Plan Overview
A 529 Plan is a type of education savings plan sponsored by either a state government or an educational institution. 529 plans offer a variety of benefits including several tax advantages. As explained by Napkin Finance, “The plans are kind of like 401(k)s for college funds.”
Savings Plans allow assets to be used at nearly any U.S. college or university as well as many accredited international schools. These plans tend to be the most popular, however, your investment return is not guaranteed.
529 plans are named after section 529 of the tax code and are a great way to begin to fund a future education for yourself or your child. They offer a variety of benefits that make them a universally attractive college planning tool despite some common misconceptions about them.
529 Plan Benefits
529 College savings plans have a wide variety of benefits such as Flexibility, Growth Opportunities, Minimal Impact on Financial Aid, and Tax Advantages.
Flexibility: Anyone can contribute to your (or your child’s) 529 plan and the beneficiaries on the account can be changed on an as-needed basis. So, if you save money for your child who later decides not to attend college or receives a full scholarship, the 529 funds can be transferred to yourself, a sibling, or a grandchild. And, if you decide you do not want to use 529 funds for educational purposes, you do have the flexibility to withdraw them, although there will be an associated penalty of 10-percent. 529’s have very few restrictions on eligibility meaning that even high-income earners can contribute to and benefit from a 529 College Savings Plan. Despite this flexibility, the account owner, typically a parent or grandparent, maintains all control over the plan and calls the shots on when and how the funds can be spent.
Growth: 529 plans offer a wide variety of investment objectives with options ranging from highly conservative to highly growth-oriented. The growth opportunities offered in a 529 plan typically far exceed those made available in a standard savings account, although returns are never guaranteed.
Financial Aid Perks: In addition to possibly generating more growth in a 529 Plan than in a savings account, you may also be more strategically positioned to receive financial aid in the form of scholarships, grants, or student loans. This is dependent on who the named “Account Owner” is on your 529 Plan. Often, having the student themselves as the account owner may count more strongly against eligibility for need-based aid. This can also be the case if a grandparent is saving on behalf of a child as withdrawals will count as income for the student. According to CNN author Katie Lobosco, “Money saved in an account owned by the child could cost you four times as much in financial aid as money in an account owned by a parent.” With that being said, the maximum deduction in need-based financial aid is 5.64% as a result of reporting a parent-owned 529 plan. This is far less than the potential 20% rate imposed on student-owned assets, such as those in a custodial account (such as an UTMA or UGMA) or traditional savings.
Tax Advantages: 529 Contributions grow tax-free and withdrawals are tax-exempt so long as they are used for qualified education expenses. Furthermore, some plans also qualify for additional tax deductions. This will depend on which state’s plan you choose as you are not required to use the plan made available in your own state. Furthermore, if you do choose to use your state 529 plan, you are not required to attend school in your state.
Drawbacks of 529 Plans
529 Plans have relatively few downsides with the most obvious being that withdrawals are restricted to education-related expenses to reap the tax benefits of the plan. Non-qualified withdrawals are subject to normal income tax as well as a penalty, typically around 10%. Additionally, as mentioned above, 529’s are considered when analyzing and deciding financial aid eligibility.
How Can 529 Funds Be Used?
Contrary to popular belief, 529 funds can be used for a wide variety of purposes. Qualified expenses typically include anything that a student might need to successfully enroll in and attend an accredited university. This might include a standard four-year university or a vocational or technical school.
This also might include the cost of a K-12 private school for your child (up to $10k per year per student) or the cost of graduate school for you or your spouse. Most commonly, 529 Funds are used for tuition, room and board, fees, books, supplies, and equipment, all of which can be costly and stressful to plan for. And, even these categories might be more extensive than you think.
Not only would the cost of a laptop computer be covered as a qualified expense, but so would the cost of internet access, if necessary, while enrolled in an accredited higher education program. These funds can even be used for off-campus living expenses, so long as the sum of these expenses does not exceed the cost of on-campus room and board as included in your university’s cost of attendance.
Furthermore, 529 funds can be used to make payments on qualified education loans although there is a lifetime limit of $10,000 for this purpose. As you can see, a wide variety of education-related expenses are covered as “qualified expenses” by 529 plans.
What Expenses Do Not Qualify?
So, what is not covered as a “qualified expense”? Although you might assume travel is necessary for your child to get to and from school, tax law does not currently deem the cost of travel as a qualified expense as far as 529 Plans go. This includes airfare, gas, and parking costs.
Additionally, pre-enrollment costs (such as prep courses) are ineligible, and 529 funds cannot be used to purchase health insurance, even if purchased through the university or college itself. Finally, the cost of extracurricular activities is a non-qualified expense, this might include membership fees for a club or annual dues for a sorority.
How to Get Started
Start as soon as possible. The sooner you start your 529 savings, the longer you will have to benefit from tax-deferred growth and minimal contribution limits.
Research the 529 plan available in your state and compare it to those available in other states.
Choose a plan and open an account either by mail or online.
Fund the account with an initial deposit and choose your investments. It is important to choose an appropriate age-based investment objective with a reasonable balance between risk and return. You can then set up recurring deposits and rest assured your money will be growing safely. You can change the investments in your plan up to twice per calendar year or as the beneficiaries on the account change.
Meet with a Financial Advisor. Advisors have the knowledge and tools necessary to help you with your college savings goals. They can help you to understand and plan for how much needs to be saved, and for how long, as well as provide guidance from a tax perspective.
In Conclusion
529 savings plans offer a great way for parents and family members to plan for anticipated future education expenses. The cost of college continues to increase on a year-over-year basis with the most recent average for in-state public college coming in at $21,950 per year for the 2019-2020 academic year. Even more alarming is the average of $49,870 per year for a 4-year private college. It is easy to see how the rising cost of education can pose an overwhelming challenge for parents and families across the board.
So, if saving for education is an important goal of yours, 529 Plans are a great place to start. Although you can open a 529 plan on your own, the guidance of an advisor can help you as you plan how much you need to save to meet your education goals, how much you’re able to save based on your current budget, and how you can best take advantage of the benefits offered by a 529 Plan.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.
Written by Kaitlyn Keeler
Kaitlyn is an enthusiastic client service intern that assists our advisors with your accounts. She is an attentive business student with a concentration in finance.
