Five Questions About 529 Plans
Have you been considering opening a 529 college savings plan? Saving for a child’s education is also an important goal for many of my clients, and 529 Plans are often the way to go.
Contributing to our children’s college education is one of my personal goals. I went to an expensive private university (NYU), and I only recently paid off those pesky student loans. We started the first 529 plan with some baby gifts, and have been contributing in small amounts (but consistently!) ever since. It wasn’t hard and I am so glad we did it.
Here are some of the questions I hear from clients on the subject:
1. What is a 529 education savings plan?
A 529 Plan is an investment account designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these plans in 1996. They are used to pay for tuition, certain room-and-board expenses, fees, books, and other qualified higher-education expenses.
You can use withdrawals from the account at many educational institutions including private colleges, public universities, community colleges, graduate schools, and trade schools around the country. Foreign schools may also be eligible.
The owner and the beneficiary of the account are typically two different people: a parent or grandparent, and a child or student.
529 plans differ from state to state, and nearly every state has at least one 529 plan available. The rules recently changed to allow usage of the funds for private school (K-12), but the rules may vary by state.
2. Why are 529 plans better than a regular savings account?
Tax benefits are the primary reason. A 529 allows you to invest for college deferred from federal and sometimes state income taxes. This means you won’t pay taxes on any capital gains generated by the investments in the account (like you would with a typical taxable brokerage account). You won’t receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals.
Withdrawals to pay for the beneficiary’s college costs are federally tax-free. Contributions are not deductible on your federal tax return, but some states offer tax benefits for contributions.
3. How will 529 college savings plans affect financial aid?
The student is usually the beneficiary of the 529 account, not the owner. For financial aid eligibility purposes, this is better in comparison to an account where the child is the owner.
If the owner of the account is a parent, the account is listed as a parental asset on the FAFSA (Free Application for Federal Student Aid). A portion of the account goes into the EFC (Expected Family Contribution) for the student’s tuition. If a grandparent owns the account, none of the value is included.
When used for college, withdrawals from 529 plans are excluded from your federal income tax return, and are not required to be “added back” when reporting your family income on the student’s federal financial aid application. 529 withdrawals for the first years of college may be reportable on the following year’s FAFSA as student income.
In summary, 529 investments may affect your child’s eligibility for need-based financial aid, but currently have less of an effect than many other types of financial accounts or sources.
Please note that rules are subject to change and some colleges will calculate financial need using their own formulas.
4. What happens if my child doesn’t go to college?
You have a few options. You could change the beneficiary to another member of the family who will use it for higher education. That could be a sibling, cousin; even yourself (hello grad school!).
You could also withdraw money out of the 529 plan, but there is a penalty if it is not used for education. Any earnings growth in the account will be taxable to you at ordinary income tax rates, plus a 10-percent penalty rate.
5. Which 529 plan should I choose?
Some states offer tax incentives if you are a state resident, so start by researching your state’s plans.
You are not limited to your state’s plan. If your state offers no tax benefit, compare performance and fees of available plans. One resource is www.savingforcollege.com.
Are you using a 529 plan to save for college?
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Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 college savings plans before investing. More information about 529 college savings plans is available in the issuer’s official statement and should be read carefully before investing. Favorable state tax treatment for investing in Section 529 college savings plans may be limited to investments made in plans offered by your home state. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan. Withdrawals for purposes other than qualified education expenses may be subject to taxes and penalties.
The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investments mentioned may not be suitable for all investors.
