Getting a college degree is a goal for many U.S. families and provides numerous benefits for the student, but college is expensive. According to the College Board’s College Cost Calculator, a child born in 2021 may need more than $222,000 to attend a four-year in-state public university, and private colleges can cost almost twice that amount. Saving early and saving as much as possible is vital. But how you save is also important for several reasons, including the impact on taxes and financial aid eligibility. A 529 plan can help ease the financial burden of college.
What is a 529 plan?
Many Americans don’t know what a 529 plan is or how a 529 plan works. A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. These accounts are sponsored by states, state agencies, and educational institutions and are authorized by Section 529 of the Internal Revenue Code. This type of plan was initially created to encourage saving for college but can now also be used for some K-12 educational expenses. Saving is less costly than borrowing because each dollar saved is a dollar you don’t need to borrow and repay with interest. Investing your savings is an even better way to gain the benefit of tax-deferred compound growth.
It’s important to know the different ways you can put a 529 plan to work for you and your children’s education, and this article touches on some of the basics you’ll want to consider. Here are four reasons why 529 plans are attractive savings vehicles to help tackle the burden of paying for college:
Investments in 529 plans grow tax-deferred, allowing the assets to build faster than they would in a taxable account. Earnings are not subject to federal or state tax when withdrawn, provided the earnings are used for qualified higher education expenses such as:
• Cost of internet access
• Books and supplies
• Certain room and board costs
Expenses related to students with special needs can also qualify. Also, many states offer residents a full or partial tax credit or deduction for contributions to their state’s plan, and some states allow you to deduct contributions to any plan, not just the state’s plan.
High contribution limits
A 529 plan allows for higher contributions than other college education savings options. Many 529 plans allow for contributions of $400,000 or more over an account’s lifetime. In addition, the current $15,000 annual tax-free gift amount can accelerate into a lump sum contribution of up to $75,000 per individual or $150,000 per couple by treating the gift (i.e., the contribution) as if it was spread evenly over five tax years — an additional tax benefit.
Improved financial-aid eligibility
529 plans are controlled by and considered the assets of the parents or other account holder and not the beneficiary child. This detail is important because guidance from the US Department of Education provides that only 5.6 percent of parental assets are counted in financial aid calculations, while typically 20 percent of the child’s assets may be considered. Thus, a 529 plan can be helpful when calculating financial-aid eligibility.
Withdrawals can be used at any eligible higher education institution and certified apprenticeship programs. A recent change also allows up to $10,000 per year from a 529 to be used for tuition at eligible public, private, or religious K-12 schools. For example, suppose your child decides not to go
to college or cannot use all the funds due to receiving scholarships. In that case, the plan can be transferred to another qualifying family member as the new beneficiary of the plan.
529 funds can be used for payment of qualified education loans up to a lifetime maximum of $10,000 for a designated beneficiary or a sibling of the designated beneficiary. Anyone can contribute to a 529 plan, which provides excellent opportunities for grandparents or others to help fund education costs.
Many factors should be addressed to determine if 529 plans are better for you than other taxable accounts to save for your child’s college education. For example, you should consider:
• Your state’s income tax rate
• Income exclusions
• Capital gains
• Length of time before college
• Whether the contributions are made in a lump sum
It’s also important to understand that if you distribute 529 plan assets for non-qualified expenses,
the earnings portion is subject to federal income taxes and may be also subject to an additional 10 percent federal tax penalty (with a few exceptions). State and local tax treatment of 529 plans varies. You’ll want to consult with your tax professional to fully understand all the implications of a 529 saving plan and how it can help you save for your child’s future.
AUTHOR: Sean Campbell, CFP® CDC® is a senior wealth counselor at Versant Capital Management, a wealth management and investment firm located in Phoenix, AZ serving high net worth people and their families since 2004. For complete information on your tax situation, you should always consult with a qualified tax advisor. While Versant Capital Management doesn’t offer tax advice, we are familiar with certain tax situation that our clients face regularly. Disclosure: Any tax-related material contained within this document is subject to the following disclaimer required pursuant to IRS Circular 230: Any tax information contained in this communication (including any attachments) is not intended to be used and cannot be used for purposes of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting marketing or recommending to another person any tax-related matter. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Versant Capital Management, Inc.), or any non-investment related content, made reference to directly or indirectly in this article will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Versant Capital Management, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Versant Capital Management, Inc. is neither a law firm nor a certified public accounting firm and no portion of the article content should be construed as legal or accounting advice. If you are a Versant Capital Management, Inc. client, please remember to contact Versant Capital Management, Inc., in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. A copy of the Versant Capital Management, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.