A 529 college savings account offers many advantages:
Designed specifically to help pay for qualified costs associated with higher education, a 529 college savings plan is a tax-advantaged account that allows for distributions to pay for things like tuition, fees, books, supplies, and any approved equipment the student may need to study at accredited institutions. In addition, you can take distributions for room and board, as long as the beneficiary of the plan is attending the school at least part time. When 529 funds are used for these qualified purposes, there is no federal income tax on investment gains (no capital gains tax, ordinary income tax, or Medicare surtax).
Typically, a parent or grandparent opens the account and names a child or other loved one as the beneficiary. Each plan is sponsored by an individual state, often in conjunction with a financial services company that manages the plan, although you don’t have to be a resident of a particular state to invest in its plan.
The ABCs of 529 plan benefits to consider:
A. Alleviate the impact on financial aid.
Many families worry that saving for college will hurt their chances of receiving financial aid. But, because 529 college savings plan assets are considered parental assets, they are factored into federal financial aid formulas at a maximum rate of about 5.6%. This means that only up to 5.6% of the 529 assets are included in the expected family contribution (EFC) that is calculated during the federal financial aid process. That’s far lower than the potential 20% rate that is assessed on student assets, such as assets in an UGMA/UTMA (custodial) account.
This lower rate means that every dollar saved in a 529 college savings plan can go a long way toward helping to pay for college without significantly affecting financial aid for the student.
B. Be more flexible.
In many ways, a 529 college savings plan has fewer restrictions than other college savings plans. These plans have no income or age restrictions and have no upper limit on annual contributions, unlike the Coverdell ESA, which limits contributions to $2,000 annually and restricts eligibility to those with adjusted gross income of $110,000 or less if single filers, and $220,000 or less if filing jointly. However, once a 529 plan account reaches a certain value—typically more than $300,000 (varies by state)—further contributions are not permitted.
Anyone can open and fund a 529 college savings plan, parents, grandparents, other relatives and friends. You may even open one to pay for your own college expenses.
C. Control the money and choose among many investment options.
Unlike a custodial account that eventually transfers ownership to the child, with a 529 college savings plan, the account owner (not the child) calls the shots on how and when to spend the money. Not only does this oversight keep the child from spending the money on something other than college, it allows the account owner to transfer the money to another beneficiary (e.g., a family member of the original beneficiary) for any reason. For example, say the original child for whom the account was set up chooses not to go to college—or doesn’t use all the money in the account—the account owner can then transfer the unused money to another named beneficiary.
Each 529 college savings plan offers its own range of investment options, which might include age-based strategies; conservative, moderate, and aggressive portfolios; or even a mix of funds from which you can build your own portfolio. Typically, plans allow you to change your investment options twice each calendar year or if you change beneficiaries.
Think carefully about how you invest your savings. A strategy that’s too aggressive for your time frame could put you at risk for losses that you might not have time to recoup before you need to pay for college. Being too conservative can also be a risk because your money might not grow enough to meet costs.
Potential tax benefits
If your 529 is used to pay for qualified higher education expenses, no federal income taxes are owed on the distributions, including the earnings. This alone is a significant benefit, but there are other tax benefits as well.
A 529 college savings plan may offer added estate planning benefits. “Any contributions made to a 529 college savings plan are considered ‘completed gifts’ for estate tax purposes, so they come out of your taxable estate, even though the account remains under your control,” Bernhardt says.
Gifts to an individual above $14,000 a year typically require a form to be completed for the IRS, and any amount in excess of $14,000 in a year must be counted toward the individual’s lifetime gift-tax exclusion limits (the federal lifetime limit is $5,490,000 per individual). With a 529 plan, you could give $70,000 per beneficiary in a single year and treat it as if you were giving that lump sum over a five-year period.2 This approach can help an investor potentially make very large 529 plan contributions without eating into his or her lifetime gift-tax exclusion. Of course, you could make additional contributions to the plan during those same five years, but these contributions would count against your lifetime gift-tax exclusion limit. Consider talking with a tax advisor if you plan to make contributions exceeding $14,000 a year.
At GunnChamberlain, we believe that retirement saving should always be a top priority, because while you can’t borrow money to pay for retirement, you can for college. Still, if college saving is among your financial goals, choosing to invest in a 529 college savings plan may be one of the most educated decisions you can make to help pay for qualified college costs. If you’re not sure how to make college saving a priority while continuing to prepare for retirement, please reach out to us to schedule a financial planning meeting with one of our professionals.