The college goal is a top financial priority of families, right up there with a good retirement. However, many parents don’t have dedicated accounts, like a 529, to save for this important goal. Or if they do, they may underutilize them. 529 plans are savings plans that are specifically designed to help you save for college and offer great tax and other advantages. Given the high-and-rising costs of higher education, most parents would benefit from using 529 accounts. So let’s review some of the benefits of these plans, so you can get started today!
The importance of getting started, Talk savings with a Financial Advisor in Austin Texas
Just opening a 529 means you now have a tool to help you save for college. You can start it with a small contribution, maybe as little as $100. Then you can automate the savings. If you are not sure how much you can save every month, start small, and plan to increase that amount over time. After a few years of consistent savings, you will see your account grow thanks to contributions and investment returns.
Talk to a Financial Advisor about the many occasions to save for
If you have a 529 account you can use birthdays, holidays, and other special occasions to save a little extra towards college. Show your kids as they grow that you are giving them a gift in their 529 accounts. It is also a good way to educate them about the importance of saving. Some plans also let you set up a funding page that you can send to family and close friends.
Tax Advantages
There are three main tax advantages of 529 plans. First, any contribution grows tax deferred. This means that you will not have to pay any yearly taxes on your earnings until you take the money out. This way your money can grow at a higher rate relative to a taxable account. The longer the time horizon, the greater the advantage of the tax deferral.
The second tax advantage is that you won’t be taxed on the money when you withdraw it for qualified expenses at a college, university, trade school, vocational school, and apprenticeship programs. Qualified expenses include tuition and fees, books, supplies and equipment including computer, computer software, and internet access and related services if used primarily by the student enrolled at an eligible education institution. You can also use your 529 assets for K–12 tuition of up to $10,000 per student per year at a public, private, or religious school. Qualified expenses also include the payments of student loans, up to $10,000.
Finally, most states with income taxes let you deduct your contributions to the 529 account up to your state limit. Vanguard has a calculator to estimate your potential state deduction.
How to find out more about Scholarships and non exempt withdrawals
The tax-free withdrawals are only for qualified expenses. If you use the funds for other expenses, any earnings (but only your earnings) will be treated as taxable income and you will incur a 10% additional federal penalty tax. Your contributions were made after tax and therefore will not be taxed.
There are some exceptions to the 10% penalty rule, including a scholarship. In the case of a scholarship, non-qualified withdrawals up to the amount of the tax-free scholarship can be taken out penalty-free, but you’ll have to pay income tax on the earnings. This means that not only you avoid the penalty, but you still get the advantage of a tax deferral.
Save for everyone, 529 plans and other options
The beneficiary on the account can be changed any time. Start saving for a child, grandchild, other family member, friend—even yourself. You can also save for an unborn child by naming yourself as a beneficiary and then transferring the account to your child once he or she arrives.
Because you are the account owner, you have control over when and how the money is spent. Since you can change the beneficiary, you can direct the account to other children or yourself later on.
Save as much as you can
Start with saving as much as you can. A common rule of thumb is to first start saving at least 10% in your retirement accounts. Anything after that can be devoted to your education savings. If you can’t do that, open a 529 anyway and save what you can. Then use birthdays, holidays and special occasions to increase the amount.
There are no annual limits to how much you can contribute to a 529. To avoid any gift tax reporting, you can contribute your annual gift exclusion of $15,000 if single, and up to a combined $30,000 per child without gift tax implications. 529’s have a special averaging rule. You can contribute a lump sum of 5 times the annual gift exclusion ($75,000 single and $150,000 if joint), and spread it over 5 years for tax purposes. Plans have total maximums amounts per beneficiary, usually between $300,000 and $550,000 per beneficiary.
Have less counted against financial aid for higher education
As long as the parents are the account owners and the child is a dependent, the savings in a 529 will have a much lower impact on financial aid for higher education than a different type of account opened in your child’s name.
How to Choose A Savings plan for My Children and Family, Talk to a Financial Planner near me in Texas
A great place to start learning about different plans is the annual Morningstar review. You may be drawn by your state’s 529 offering, but often that may not be the best for you. Evaluate the tradeoff between the benefits and costs across plans.
Compare the tax advantage of a plan on one hand with the costs and investment options available on the other. If you live in a state with income taxes, your state may offer a benefit in terms of tax-deductibility of the contributions. However, there may be a limit to deductibility, and if the in-state plan has high fees and poor investment options, you may be better off with a plan offered by a different state.
If your state does not have income taxes or offers no deductibility, the 529 is still a tax-advantaged plan from a federal tax perspective. Again, focus on low administration fees and good low-cost investment options. Morningstar gold rated plans score highly on these dimensions.
Until Next Time!
Massi De Santis is an Austin, TX fee-only financial planner and founder of DESMO Wealth Advisors, LLC. DESMO Wealth Advisors, LLC provides objective financial planning and investment management to help clients organize, grow, and protect their resources throughout their lives. As a fee-only, fiduciary, and independent financial advisor, Massi De Santis is never paid a commission of any kind, and has a legal obligation to provide unbiased and trustworthy financial advice.
