The “Cliff’s Notes” about 529 College Savings Plans

By Philip Bachman

It’s hard to believe back-to-school season has already happened this summer! With school in session again, now is a thoughtful time to chat about the youngsters’ future college savings. Like this year’s school season, younger kids’ college years will be here before we know it.

This article will discuss an oft-mentioned type of savings plan for post-secondary education: the 529 college savings plan. The popularity of these types of investment accounts has been rising in recent years. Assets in 529 plans have grown by over 60% in the last five years, to $253.2 billion in 2015, according to ICI 529 Plan Program Statistics. It’s good to see families thinking proactively about the high price tag of college.

Our firm posted a blog article about 529 plans in 2013, which is here. While there is plenty more to discuss about them beyond the following, below are the highlights – or shall we say the “Cliff’s Notes” – of 529 plans:

Why consider a 529 plan?

The primary attraction to a college savings plan is the tax advantage. Earnings grow tax-deferred and distributions are federally tax-free, provided that the money is used for qualified education expenses for the beneficiary. The account can therefore compound at a faster rate than a taxable account.

How do contributions work?

Contributions are made into a 529 plan with after-tax dollars, so unfortunately there’s no federal tax deduction for contributing. However, similar to a Roth IRA, the account’s growth from then on will be tax-free if the funds are ultimately used for the proper purpose. There are no income restrictions for contributing into a 529 plan. Contributions are considered gifts for federal gift tax purposes, but it’s possible to contribute up to five times the annual gift tax exclusion amount in a single year without the contribution being subject to federal gift tax. (For 2016, the annual gift tax exclusion amount is $14,000 for an individual donor per recipient or $28,000 for a married couple donor per recipient.)

What is a qualified education expense?

Qualified education expenses are defined by the IRS. Such expenses generally include tuition, room and board, and books at any accredited college nationwide. Other common college-related expenses like buying a computer (if required to take a course) and paying for off-campus housing (within specific parameters) are also eligible.

Do I have to be the child’s parent to start a 529 plan?

Anyone can open and contribute to a child’s college savings plan. It doesn’t have to be a parent. Grandparents, aunts, uncles, and even friends can contribute to an account. The adult controls the account and the withdrawals; the student is just listed as the beneficiary entitled to the account’s benefits for higher education.

What if the child doesn’t go to college or doesn’t use all of the funds?

There are options. Usually the worst financial move is to simply withdraw the money. Although that is an option, doing so would trigger income tax on the account’s growth plus a 10% penalty. A better option, if practical, is usually to name a relative of the child as the beneficiary, such as a sibling, niece, nephew, or other family member.

Our firm has much experience helping clients to strategize, set up, and manage college savings plans. As with investing in general, the earlier in the child’s life a college savings account is set up, the better. Although it passes quickly, time is on our side as investors!

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