According to the College Board a 2018 study, named The Trends In College Pricing, by the year 2024, the average sticker price of a public education in a state college is expected to move up to $34,000 per year. For private schools that number is estimated to be around $76,000 a year. Let’s face it, college is getting ridiculously expensive and if you have little ones at home that you expect to help pay for their college, then you need to know how to set aside money for that. 529 savings plans are a particular investment vehicle allowing you to save or put away money specifically for education TAX-FREE!! Yes, you read that right, tax-free. Now, let’s consider what you may or may not know about 529 plans.
First, 529 savings plans allow you to make tax advantageous investments. So, when making contributions, it grows tax-deferred. The catch, because there’s always a catch, is when you use to withdraw the money from a 529 plan, it must be used for qualified purposes or be subject to a penalty.
According to the Internal Revenue Services Code, those things are tuition fees (like fees on the school), books, equipment, supplies, and even room and board is considered a qualified expense. However, when it comes to the room and board, the rules require you to be enrolled at least half-time at a university or a vocational school, not a part-time student.
Basically, 529 plans are state-sponsored plans. However, you are not required to participate in your home state’s plan. You can absolutely invest in another state’s plan. For example, even though I live in Tennessee, I could invest in the Alaska 529 plan.
Although you can invest in another state’s 529 plan, that doesn’t mean it is a good idea. Some states, do not have an income tax; while others do. So when it comes to being an out-of-state investor, the danger is, if you invest in a state where there is no income tax you run the risk of not benefiting from a tax deduction if you live in a state that does have an income tax. For example, Indiana, I believe, allows you to get a benefit for making a contribution to the Indiana State 529 plan. There are many states which do this, but not every state so check the rules for that state’s 529 plan before investing. For example, in Tennessee, we do not have a state income tax. Therefore, there is no deduction for making a contribution.
Here’s where it gets even murkier. There are five states which allow you to give an income tax deduction even if you invest the money in another state’s 529 plan. Those states are Arizona, Kansas, Missouri, Montana, and Pennsylvania. So if you live one of those states, and choose to contribute to the Alaska 529 plan, it is possible that you are eligible for a deduction on your current state income tax. Again, check the rules or talk with a financial professional to help you make the most tax advantageous choice
Many people worry that if they don’t end up using the money for college, then they lose the money. That’s simply not true. So, let’s say that you contributed $30,000 to a 529 plan and the account grows to $40,000. That’s $10,000 beyond your initial investment.
Now let’s say that “Little Jimmy” decides college isn’t for him and decides to start his own landscaping business. Well, what about the $30,000 you invested in a plan that was to pay for “Little Jimmy’s” college? What happens now?
Well, if you want to take the money out, you can. Your initial investment of $30,000 can always be taken out without penalty. As for the $10,000 in gains you made on your investment, you will just pay ordinary income tax on it along with a 10% penalty.
Let’s look at another possible scenario. So “Little Jimmy” decided against going to college, but you have “Sweet Sally”, his little sister and she does want to go. Well, then you simply transfer the money from “Little Jimmy” over to “Sweet Sally”. In other words, the money is transferrable from one child to another if the child the account was initially set up for decides not to use it. There is no issue with that.
For example, we will say you decide to open a 529 plan in Georgia. Now the time has come to send your little scholar off to college, and you want to start using the 529 investment money. Your child chose a school in Nebraska; now you are wondering if the money can be used that way.
Here’s the thing, 529 plans can be used at any eligible college or university thanks to Title IV Federal Student Aid. So, anything that is eligible for a Federal Student Aid can be used for a 529 plan.
Where is get’s tricky is when people want their child to go to a certain college, let’s say for religious reasons. If this is you, at this juncture, you could run into some roadblocks. Some private universities are not eligible to receive student loan funds. There are certain schools in Utah, as well as Christian based universities, which may not be eligible for a Title IV Federal Student Aid. So be careful with this.
Another quick thing to point out is that you can also use a 529 plan for certificate programs and vocational-technical schools that are eligible for Title IV.
Any amount a parent or a student own in a 529 plan is treated as a parental asset. So, just because mom and dad own the 529 plan and have now decided they want to shift the money to their student, it is still considered as an asset for the parents. Additionally, when the school calculates the Expected Family Contribution, or what’s known as EFC, only a maximum of 5.64% of the parental assets are counted. So, a higher EFC means less financial aid.
Many times, I meet grandparents who want to contribute to 529 plans for their grandkids, yet they often think they cannot. Well, that is not true. A grandparent can open and put money in a 529 plan. Here’s an important tip to remember. Unlike the parental asset from the previous point, grandparents’ assets are not reportable on FASFA, only the parents and child’s. Keep in mind though that the distributions from a grandparent-owned 529 plan, may be considered student earnings for the purpose of the FASFA. Therefore, despite the account not being an asset, the distributions could be subject to them.
This particular plan is the only prepaid 529 plan not ran by a state. Historically, private plans were state-run and offered in advance to the state. With nearly 300 private colleges and universities in the U.S., they joined together to offer tomorrow’s tuition at today’s rate. It is the only 529 plan that is not a state-run 529 plan.
One of the major benefits of using these, they do not carry market risks. So, the investment performance of the prepaid is measured by tuition inflation. The increase in inflation is what governs the performance of this investment vehicle, not the stock market. For someone who’s extremely conservative, some people want to go with that.
While it seems not facing market risk is the best idea. However, you could be facing the risk of buying a plan that could fail over the years. So for example, the College of Illinois is on a path to insolvency according to a recent story in the news. So that means, if they do, things could get messy.
While both plans grow tax-free, the Coverdell Education Savings Account (ESA) is a worthy competitor because it offers more flexibility. So just like a 529 plan, an ESA can not only be used for college, but for certain K-12 expenses as well. Unlike the 529 plan, there income restrictions, along with special rules for beneficiary changes, on a Coverdell. So you have to be aware of the amount you can contribute to the ESA. Know that what those income restrictions are when it comes to Coverdale ESA too.
Grandparents often want to give money to the grandkids, other than putting it in a 529 plan. They often say, well if I gift money to my grandkids, it’s more favorable from a financial aid and income tax perspective than if I put it into a 529 plan. Again, this statement is completely false.
So, historically, whenever people give money to kids they put into what’s called a UGMA or a Uniform Gift To Minors Act account. They make contributions to the UGMA. Years ago, it was the preferred method for college financing. But the problem with that is that the UGMA account is subject to the Kiddie tax rules; that means which means that the account value or the UGMA account is taxed at the child’s tax bracket or the parent’s higher tax bracket. So you will want to be careful with that.
Additionally, a UGMA account will count toward the FASFA as student income. This money is considered to be money owned by the child. Due to this, it’s going to report on the FASFA reform, which is, in turn, going to lower the financial reward.
So, there are ten facts about a 529 plan that you may not have known about. Some make them very complicated to handle; my advice is to talk to a CERTIFIED FINANCIAL PLANNER™ to get the details of what would work best for you.