No matter what age your children or grandchildren are, the one constant you can rely on when considering their education expenses is that the cost of an education seems to get more expensive every year. The average annual cost for a 4-year, in-state public college is over $20.000, and it tops $45,000 per year for a 4-year private college. Writing a check for that every year isn’t something that the average person can handle without more than a little pain.
Planning for your children or grandchildren to attend college requires a coordinated plan that involves a great deal of planning - ideally, well before the dormitory move-in date. 529 plans are an integral part of that plan. 529 plans are advantageous to the donor and the benefits can be significant for the student, including tax advantages, minimal negative impact on qualifying for student aid and forgiving rules on how the money can be spent.
Recently, tax reform law has allowed for greater spending levels of 529 plans. These rules allow families to spend up to $10,000 per beneficiary per year on elementary or high school tuition from a 529 plan. Understanding the complexities of a 529 plan can help you navigate one of the most daunting life expenses parents and grandparents can face in their lifetime.
529 savings plans tax-advantaged accounts designed specifically for education savings. Distributions from a 529 plan can pay qualified education expenses from the elementary to postgraduate level. College or postgraduate beneficiaries can apply funds from a 529 to tuition, fees, books, supplies and room and board for a full-time student at an accredited institution. Even computers are covered. When 529 funds are used for these qualified expenses, there is no federal income tax on distributions, including investment gains. An account is usually opened by a parent or grandparent (Donor) and names a child as the beneficiary. Each plan is sponsored by an individual state, who will work with a specific financial services institution that will manage the plan. You don’t have to be a resident of a particular state to invest in its plan, which allows one to choose the best plan available regardless of where it is managed.
For many parents, the plan to send your child to school relies heavily on securing financial aid. Since 529 assets are considered to be owned by the parents, and not the student, 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 significantly below the 20% rate that is assessed on assets owned by the student, such as in an UGMA/UTMA (custodial) account. Following the SECURE Act’s enactment, now students can even apply these funds to cover expenses while they apprentice - an expense historically passed on to the parent. The act further expanded to allow students to use tax-free distributions of up to $10,000 to repay student loans.
The 529 college savings plan has fewer restrictions than other college savings plans. These plans have no income or age restrictions and the upper limit on annual contributions is typically $300,000. Anyone can open a 529 for a family member and, as is often misunderstood, if the original beneficiary should not use the entire 529 fund, assets can be passed on to another qualifying family member. As long as the funds are utilized for approved expenses, any member of the family can use these assets once the original beneficiary has exhausted the need.
Unlike an account that eventually transfers ownership to the child - like a custodial account - the assets in the 529 are controlled by the parent. Assets are essentially owned by the parent so expenses are paid at their discretion. This structure makes it harder for students to misuse the funds while also making it easier to pass excess funds to another beneficiary. Every state 529 savings plan offers its own range of investment options. These plans can include ETFs, Mutual Funds, Age-Based Funds and different risk-based strategies that make it easy to tailor portfolios for each student as their needs change. Portfolio changes can be made, usually twice a year. Asset allocation is something that should be carefully considered. The allocation of these assets should consider the onset of need similar to how we look at retirement and retirement assets - the closer we get to distributing the funds, the more conservative the funds should be allocated. As a rule, the sooner a 529 plan is established, the more aggressive the initial allocation can be. This allows for maximum potential for growth.
Perhaps the best reason of all to establish this type of account is that if a 529 is used to pay for qualified education expenses, there are no taxes on any distribution from the fund, including gains. Other tax benefits include the extension of gifting limits typically held to $15,000 per beneficiary, per year. With the prepaid option in a 529, donors are allowed to fund up to 5 years of a 529 in a single lump sum - $75,000 maximum. This allows a longer time for assets to grow while the beneficiary is still young as well as allowing for a more aggressive allocation for a longer period of time. Donors could make additional contributions to the plan during those same 5 years, but these contributions would count against your lifetime gift-tax exclusion limit.
While there are many ways to contribute to your child or grand-child’s education, few offer the advantages you find with the 529 savings plan. As with any investment plan, the best time to start is right now. For educational savings plans, this is especially true. In most cases, retirement plans are set up with a time horizon of several decades until the need for those assets arises. Parents have far less time to save for educational expenses.
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