Top 10 Questions We Receive on 529 College Savings Plans

Top 10 Questions We Receive on 529 College Savings Plans

Worried about saving for your child’s college education? It’s a valid concern for many parents, especially with the rising cost of both public and private education options.

Unfortunately, too many parents are putting away their hard-earned money in regular savings accounts, unaware of the benefits of the state-sponsored, tax-advantaged 529 education savings accounts. These plans are specifically designed to encourage parents to save for future education costs, and they come stacked with benefits — and fine print.

We often get the same great questions from our clients: How are the 529 savings plans set up? What are the downsides? What happens to leftover funds? Can you invest the money?

There are so many questions surrounding the 529 savings plan accounts, so despite the many benefits, many Americans still don’t use them — or understand them. But the 529 plans are not as complicated as they may seem. We’re here to help you better understand these plans – and take advantage of them. Before you open up your 529 savings plan, here’s everything you need to know.

How Is A 529 Savings Plan Set Up?

There are two types of 529 Savings Plans: the college savings plan and the prepaid-tuition program. What’s the difference? Let us explain.

The college savings plan is the most common type of 529 Savings Plan. With this option, parents, grandparents, and other loved ones can invest money for the beneficiary’s qualified

education expenses (more on this later!). Some state-sponsored 529 plans are “Self-Directed” and may be set up and funded online. Some state-sponsored plans are set up through a Financial Advisor.

The prepaid-tuition program is the other type of 529 savings plan, and it’s much less common. The prepaid-tuition program will let parents, grandparents, and others prepay tuition at participating schools – at the set price today. This only applies in participating states at participating schools.

Some states will offer both types of 529 plans, and others will not.

Is a 529 Savings Plan a Good Idea?

There are plenty of benefits that make a 529 savings plan a great option for many parents.

At the federal level, contributions to your 529 plans will not be tax deductible. However, many states offer state income-tax deductions or credits. For example, in Massachusetts, contributions to 529 plans of up to $1,000 a year by an individual (or $2,000 per year by a married couple filing together) are deductible.

Another big benefit: your money will grow, tax-free, for years — and when you’re ready to take it out to pay for tuition and other qualified education expenses, the money will not be subject to federal tax. In many states, it won’t be subject to income tax, either.

What’s a qualified education expense in a 529 savings plan? Well, it covers a wide range of expenses, including tuition, room and board, books and computer equipment, to name a few. One of our favorite newer features is the ability to use the 529 Plan for up to $10,000/year in K-12 tuition.

In addition, these plans have a number of investment options – and the accounts have plans where you can invest only a small amount of your money. You can also transfer money in the account to other beneficiaries. Low cost direct-sold plans are also available through financial advisors (like us!).

What Are The Downsides to a 529 Savings Account?

There are definitely more benefits than downsides to opening a 529 savings plan. However, you may face big penalties if you use the money for something that is not a qualified expense.

There’s one more big consideration: if you do plan to apply for financial aid, your child’s need-based financial aid may be reduced if you have a 529 Savings Plan.

In addition, if you plan to invest the money, you cannot buy individual stocks with this specific plan. The plan does have a number of different investment options, but it’s far less choice than designing your own portfolio.

How Can I Use The Money From my 529 Savings Account?

Most colleges and universities in the U.S. accept money from the 529 savings plan for both undergraduate and graduate degrees. In addition, you can even use the money for eligible institutions outside the U.S. You’ll need to check the College Savings Plan Network.

Investment Options for a 529 Savings Account

The 529 Savings Plan comes with a number of investment options, but there are certain restrictions. For example, as we said, you cannot buy individual stocks.

Most people will opt for a portfolio allocation that tends to be much more conservative, especially as your child gets closer to attending college. However, you can also pick 100% equity funds, fixed income funds, balanced funds, and stable-value funds – to name a few.

Just because you invest the money a certain way doesn’t mean that you can’t change it later. You can move some – or all! – of your money into a different account to invest differently. If this seems overwhelming, don’t worry, we can help out with picking the right allocations for your goals. You can also swap your investments to a different state’s plan, too, but only once in a 12-month period. Some states may penalize this shift.

Is There a Max Investment Amount?

Yes, there is. Each state will set their own limits on aggregate contribution limits per beneficiary. Those limits will range from $235,000 to $542,000, according to savingforcollege.com. Once you hit those limits, you can no longer contribute – but you can continue to accumulate earnings.

There are no annual contribution limits, but you DO need to be careful: contributions are considered gifts in the eyes of the federal government. In 2021, you can contribute $15,000 per donor, per recipient, free of federal gift taxes.

You can also make a lump-sum tax-free contribution to the savings plan: $75,000. Once you contribute, you can spread it out over your taxes in the next five years. Consult your tax advisor on lump-sum contributions to 529 plans – as it can get tricky from an Estate Planning and Gift Tax point of view.

How Do I Find a 529 Savings Plan?

There are a number of ways to find a 529 Savings Plan. If the whole idea still seems overwhelming, we can help set up the perfect plan according to your needs.

You can compare different state plans on the College Savings Plan network here. Start by looking at your state-specific plan options first to determine if there are any benefits specific to your own state. You might find a state-specific plan that makes for a great, competitive option.

Otherwise, you can pick from 529 plans sold by advisors, or those looking for professional advice. These plans may be more expensive, but they come with professional help and advice.

Who Can Open a 529 Savings Plan?

Just about anyone can participate or contribute to a 529 Savings Plan. Parents, grandparents, other relatives, or family friends can own an account – or contribute to your account. In fact, you can even set up a 529 plan for your own education expenses! In many states, a trust, corporation, nonprofit or government entity can open an account as well.

However, the beneficiary needs to be a U.S. citizen or resident alien with a federal tax identification number and Social Security number.

Will a 529 Plan Affect Financial Aid?

Earlier, we mentioned that a 529 Savings Plan could affect financial aid. It’s true that it could affect your financial aid, but we always tell our clients that benefits from the 529 plan will outweigh the effects on financial aid in almost all cases.

In the world of financial aid, assets in an account owned by a dependent student, or one of their parents, will be considered parental assets. In these situations, only about 5.64% of the account will be considered in the FAFSA (or Free Application for Federal Student Aid) calculation every year. It’s a much better deal than counting the assets as the student’s own assets. The distributions under this ownership structure will not reduce your eligibility for aid. So it’s a pretty good deal, all things considered.

If your grandparents own the 529 Savings Plan, the assets will not have any effect on the FAFSA calculations. However, the distributions will count as student income – at least with these calculations. In the future, FAFSA will no longer ask about those 529s at all.

What Happens to Any Leftover Funds?

The very nature of the 529 Savings Plan forces you to think ahead — but what if your child doesn’t end up going to college? Or what if they do go to college, but they don’t use all the money? What happens to leftover funds?

Good question! Regardless of how old the beneficiary is, you (the account owner) will retain control of the assets. That means that you can change the beneficiary at any time to another

family member. Think: a sibling, a grandchild, a stepchild, a legally adopted child, an aunt, – the list goes on! You are free to transfer the assets to another beneficiary.

However, if you did not want to do this, you can opt to withdraw some (or all!) of the money for purposes that are not qualified education expenses. You will pay a penalty for the withdrawal, though. Any earnings withdrawn will be subject to both state and federal income tax – PLUS a 10% federal tax penalty. You may also face additional fees or penalties charged by your plan.

Is The 529 Savings Plan Right For You?

That’s a great question! There are many tax and savings benefits to opening up a 529 Savings Plan for a beneficiary, but even so – you still may have some lingering questions.

Don’t be a stranger – drop us a line, and we’ll discuss how we can help with college planning as part of an overall financial and investment plan.

Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such a state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

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