College Planning: 529 College Savings Plans
Learn More about this State-Sponsored Investment Account for Educational Costs
As a parent, you want the very best future for your children – but what happens when that future comes at a substantial cost? If you dream of a private school college education for your kids, it just might.
For parents who are hoping to cover the partial or full costs of college, a 529 college savings plan may be a useful tool. Designed specifically for educational costs, a 529 plan is a state-sponsored investment account that offers many advantages. However, it is easy to make missteps with these plans that could cost you big down the road, so it’s important to learn all you can before starting one.
Understand Plan Variations
As with many other financial instruments, it often pays to shop around. All fifty states and the District of Columbia offer at least one 529 plan, and you are not necessarily limited to choosing your state’s plan. You will want to consider the differences among plans, especially in these categories:
- Investment Options. The performance of your 529 is based on its underlying investments, and the funds offered will vary by plan manager. Make sure you choose one that aligns with your goals.
- Fees. Plans may charge annual fees, fees to open an account or account maintenance fees. Be sure you know your total cost before choosing a plan.
- Tax Advantages. One benefit to choosing your home state’s 529 plan is that it may qualify you for state income tax breaks. Your earnings will always grow free of federal taxes, but about half of the state plans also offer a state tax deduction or credit.
Consider Impact on Financial Aid
A 529 plan could possibly impact how much financial aid your child is eligible to receive. This is because of the way income must be reported when filling out the Federal Application for Federal Student Aid (FAFSA). If the parent is listed as the custodian of the 529 account, then the money is reported as parental assets on the FAFSA. If the child is the custodian but remains a dependent, then the money is still counted toward parent assets.
However, if another well-meaning friend or relative opens a 529 account on behalf of your child, any distributions used are considered to be part of the child’s non-taxable income – meaning they have to be reported on the FAFSA under the child’s assets. Since the FAFSA takes into account the prior two years of income, anyone who has taken 529 distributions would appear to have a higher income and, thus, qualify for less federal financial aid. Family members who are hoping to help finance your child’s college education are better off contributing to a 529 that you open instead.
Know What You Can Use the Money For
Since the purpose of a 529 plan is to finance educational endeavors, any funds withdrawn must be used for qualified expenses. Otherwise, you will be forced to pay taxes and penalties on the money you use. Qualified expenses include things like tuition, books, and supplies and equipment like laptops that are required for coursework, but campus insurance or travel costs for flying to and from college are not covered. Room and board costs are usually covered as long as your child is enrolled for a certain number, of course, hours, but the coverage is limited to the college’s officially stated room and board cost even if a student’s actual invoiced cost is greater. Student loan repayment gets tricky – 529 plan distributions can only be used to pay down a loan in the same year the loan is taken out. For these reasons, it is important not to overfund the 529 account. You don’t want to unnecessarily pay taxes and fees on funds left within the 529 because they could not be used for educational purposes. Many times, investors will use the 529 as a supplement for college planning. Fund the 529 enough to receive some tax breaks, and this part of your college funding will grow tax-deferred and hopefully, tax-free when you withdraw the funds. There is no “perfect” amount to fund, to fully pay for college, as your child’s needs and circumstances will vary greatly over the years.
A recent legislative change made through the Tax Cuts and Jobs Act of 2017 added a new qualified expense: up to $10,000 annually for K-12 private school tuition. No other K-12 costs are covered, however.
Understand the Gift Tax Exclusion
Under IRS rules, contributions to 529 plans are considered a gift to the beneficiary, meaning they can count toward the gift tax exclusion. An individual may gift up to $15,000, and a married couple up to $30,000, and these contributions will not be counted against your lifetime gift tax exemption.
There is also a special rule for 529 plans that lets you front-load 529 gifts to your child. You are permitted to contribute five years’ worth of gifts in one year without it counting against your lifetime gift tax exemption. If you choose to fund the 529 account in this manner, you must wait five years before making any additional contributions. This is an important consideration for long-term financial planning.
When it comes to paying for college, a 529 plan can be an incredible resource. While the plans have some complexities 529 accounts may very well be a good match for your personal circumstances. These accounts can also be rolled over from one beneficiary to another. If your first child does not use all the funds within the 529, those funds can be rolled into the second child’s 529 plan. If you’d like to learn more, please reach out to us today. We’ll be happy to answer your questions and help you determine whether a 529 is the best college savings vehicle for you.