Many of our clients inquire about starting a 529 plan to make sure their grandkids can go to college and not have to start their adult lives with a crushing debt load. The average college graduate in 2018 owes around $30,000! Student loan debt is preventing young folks from buying houses, investing for retirement, and starting businesses. It is also one of the reasons so many young people move back in with Mom and Dad after college.
The cost of a college education has increased faster than any other category over the past 25 years (double the rate of medical expenses). It has gotten to the point where many people are starting to question whether the degree is worth the cost. Most people still decide that college is worth the cost, and research shows college graduates have higher average life satisfaction than those without degrees.
The point of today’s article is that financial support for education is one of the greatest gifts you can give to anyone. To that end, clients frequently ask what is the best way to provide financial support for their kids and grandkids. The answer may be a 529 college savings plan. The most frequently asked questions and corresponding answers about the 529 plan for college savings follow below:
1) What is a 529 plan and how does it work?
529 plans are investment accounts designed specifically for college savings. There are two major types of 529 plan: Savings Plans and Prepaid Tuition plans.
Prepaid Tuition plans allow you to pay a fixed amount to a specific state institution now for a guarantee that your child’s tuition will be covered at that state institution when he or she attends it in the future. This plan may be a good deal. If tuition continues to increase at 8% a year, it is like having an investment with a guaranteed 8% return if your student ends up going to that institution.
College savings plans are much more commonly used because they are more flexible. The savings plans enable you to invest money to be used for the beneficiary’s qualified higher education expenses. Your money is typically invested in mutual funds offered by the plan, with no guarantee as to how much will be available when the beneficiary enters college. The savings plans allow you to use the account value at any Eligible Educational Institution, which includes most community colleges, public and private colleges and universities, and vocational schools.
2) What are the tax benefits of a 529 plan?
You do not get a federal tax-deduction for contributing, although some states offer a state income tax deduction. Naturally, you must live in that state and invest in that state’s plan. Earnings in the plan grow tax-deferred and can be withdrawn tax-free as long as they are used to pay for qualified higher education expenses, which include tuition, books, and certain other fees and expenses such as computer technology or Internet access.
3) How many 529 plans are available and what are the differences?
- Over 80 different 529 plans are available since many states offer more than one plan. You can invest in any state’s plan, no matter which state you live in.
- Each plan has different investment options and fees. Some plans enable the account owner or their financial advisor to pick the mix of mutual funds from a menu of fund options. Other plans automatically pick the investments based on the beneficiary’s age. The investment mix is automatically reallocated and becomes more conservative as the beneficiary approaches college age. Many other options are available, so talk to your financial advisor before making a choice. Alternatively, you can research it yourself on dozens of websites such as savingforcollege.com.
- Some states offer state income tax benefits to residents who contribute to their state’s plan.
4) Can a 529 plan have multiple owners and multiple beneficiaries?
No. Each account has a single owner and a single beneficiary.
- A husband and wife cannot even be joint owners for their child. One parent is the account owner and a successor owner can be named in case the original owner dies.
- You need a separate account for each beneficiary. In other words, you would need three separate accounts, if you have three kids. However, you can change the beneficiary on any account at any time to another family member.
- Anyone can contribute to a 529 account. Therefore, parents and grandparents could contribute to the same account, or they could have separate accounts for the same beneficiary.
- States that offer a state tax deduction for contributions may only offer that to the account owner. Therefore, it is possible that you are missing out on a potential tax deduction if you contribute to a 529 account you do not own.
5) How much can be invested in a 529 plan?
Individuals can take advantage of the annual gift tax exclusion by contributing up to $15,000 ($30,000 for married couples) per beneficiary, per year. A special rule applicable only to 529 plans allows an individual to accelerate up to five years’ worth of annual exclusions by contributing up to $75,000 ($150,000 for married couples) in one calendar year. The donor can only take advantage of this special rule by filing a federal gift tax return, IRS Form 709. Don’t be dissuaded by having to file a gift tax return, as they are pretty simple.
Grandparents can set up accounts for grandchildren, transferring large sums from their estates (potentially reducing future estate taxes) while providing for their grandchildren’s education.
6) How does a 529 plan affect a student’s ability to get financial aid?
Most need-based financial aid is simply a student loan. So, money saved for college through 529 plans will reduce the amount of debt your student eventually needs to pay back. The income and assets of the family are used to determine the Expected Family Contribution (EFC) when applying for financial aid. Twenty percent of assets in the student’s name (e.g., custodial accounts) are counted toward the EFC, only 5.6% of assets owned by the parent (e.g., 529 plan) are counted. Zero percent of any assets owned by a grandparent is considered in the EFC toward financial aid. Therefore, there can be an advantage in terms of qualifying for student loans by having a grandparent as the owner of your student’s 529 plan.
7) What happens if the beneficiary does not go to college?
- You can change the beneficiary of any 529 plan another family member. The eligible family members include adopted children, parents, siblings or stepsiblings, stepparents, first cousins, nieces or nephews, aunts or uncles.
- You can withdraw the funds and not use them for education. That is called a non-qualified distribution, which results in income taxes and a 10% federal tax penalty on the earnings.
- The money can be withdrawn without penalty if the beneficiary dies or becomes disabled.
The bottom line is the sooner you start a 529 plan, the longer the funds have to grow tax-free. Call or email if you have questions. Have a great week.